Audit of Inventories

AUDIT PROCEDURES
 

1. Observe physical inventory counts

 Test shipping and receiving cut-off procedures.

 Account for all inventory tags and count sheets used in recording the physical inventory counts
 Test the clerical accuracy of inventory listings
 Trace test counts recorded during the physical inventory observation to the inventory listing
 Reconcile physical counts to perpetual records and general ledger balances and investigate significant variations
 Test inventory transactions between a preliminary physical inventory date and the end of the reporting period.

2. Obtain confirmation of inventories at locations outside the entity

3. Review perpetual inventory records, production records, and purchasing records for indications of current
activities
4. Analytically review the relationship of inventory balances to recent purchasing, production and sales activities,
and to anticipated sales volume.
5. Examine paid vendor’s invoices, consignment agreements, and contracts
6. Examine analysis of purchasing and manufacturing standard cost variances
7. Examine inventory turnover analysis
8. Review industry experience and trends
9. Examine sales after year-end and open purchase order commitments
10. Obtain confirmation of inventories pledged under loan agreements
11. Review drafts of the financial statements
12. Compare the disclosures made in the financial statements to the requirements of PFRSs

 
FOR CUT-OFF PROBLEMS
 

1. Determine the validity of the sales or Purchase Transaction

 
In considering the validity of Sale or Purchase transaction, consider the following items:
 
As a rule of thumb assumption, a Sale is valid upon delivery and a Purchase is valid upon receipt. Exceptions:

1. Goods in Transit

 FOB Shipping Point /FOB Seller or Seller’s Location include as inventory of buyer (plus freight in)
 FOB Destination/FOB Buyer or Buyer’s Location include as inventory of seller (exclude freight out)
 Cost of Insurance and Freight (CIF) include as inventory of buyer upon delivery to carrier (plus cost of insurance
and freight)
 Free Alongside (FAS) the vessel include as inventory of buyer upon possession of the carrier (exclude freight cost
to vessel, include freight cost from Vessel to Customer)

1. Special Sale/Purchase Agreement

2. With delivery/receipt but not yet valid sale/purchase

 Consignment agreement – valid upon sale of consignee to third party customer

 Sale on approval with right of return (where likelihood of return cannot be reasonably estimated) – Valid
upon approval of third party customer or lapse of period within which return is allowed.
 Inventory financing/Park Sale/Product financing – Loan agreement only, inventories were merely used as
collateral for the loan.

2. Without delivery/receipt but is already valid sale/purchase

 Bill and hold agreement (e.g. special order from customers)

– Segregated goods – mere segregation of goods does not exclude the same from the seller’s inventory, unless the
problem identified that sale is covered by a special sale agreement.
 

2. Determine whether sales/AR or purchases/AP has been recorded in the Sales or Purchases Journals. (Based on
the recording of the related sales/purchase invoice)

3. Determine whether inventories were Excluded or Included in the yea-end physical count.

 
If the problem did not indicate whether goods under consideration has been included or excluded from the count, the
following assumptions are to be made:
 all deliveries (on sale) made on or before the count date are excluded from the count, all deliveries made after
the count date are included in the count, unless otherwise stated by the problem.

 All receipt (on purchases) of goods on or before the count date shall be included in the count, all receipts after
the count date are excluded from the count, unless otherwise stated by the problem.

Sales Cut-off

Deliveries on before Deliveries after the

the count count
date. EXCLUDED date. INCLUDED

COUNT DATE

Receipts on before Receipts after the

the count count
date. INCLUDED date. EXCLUDED

Purchases Cut-off

 
If it is a valid sale, the receivable should be recorded, the Inventory should be excluded.
If it is not a valid sale, the receivable should not be recorded, the Inventory should be included.
If it is a valid purchase, the payable should be recorded, the Inventory should be included.
If it is not a valid purchase, the payable should not be recorded, the Inventory should be excluded.
 
FOR INVENTORY ESTIMATION PROBLEM
 

1. Gross Profit Method

 
Cost of goods available for sale (actual*)                   xxx
Less: Cost of Sales (estimate**)                                 (xxx)
Estimated Ending Inventory                                       xxx
 
*COGAS is actual – consider all items included in the computation of Cost of goods available for sale (Inv. beg +
Purchases + Freight – in - Purch Discount – Purch Returns and Allow + Dept Transfer In – Dept Transfer out –
Abnormal spoilage, breakage, shrinkage)
 
 
** COS is estimated by:
            Gross Sales x Cost Rate (if GP is based on sales)
            Gross Sales / Selling Price Rate (if GP is based on cost)
 
***For the purpose of estimating Cost of Sales:
Assume that all sales were made under the normal GP rate thus, when computing gross sales:

 ignore sales discount to customers

 add back special discounts to gross sales (e.g. employee discounts)
 deduct sales returns from gross sales
 ignore sales allowances (deduct if sales returns and allowances as single account is provided)
 normal spoilage, breakage, shoplifting losses shall be added back to gross sales at selling price

2. Retail Method

 
Cost of goods sold available for sale (at Retail) ^                              xxx
Less: Cost of sales (at Retail) = Gross Sales ^^                                (xxx)
Estimated ending inventory (at Retail)                                               xxx
Multiply by: Cost rate (LCA o Ave)                                                     x%
Estimated ending inventory (at Cost)                                                 xxx
 
 
Beginning Inventory Cost Retail  
Add: xx xx  
Purchases      
Freight In xx    
Less: xx    
Purchase allowance      
Purchase discount (xx)    
Purchase returns (xx)    
Add: Department Transfer In or Debit (xx) (xx)  
Less: Department Transfer Out or Credit xx xx  
Less: Abnormal Spoilage/breakage/shrinkage (xx) (xx)  
Add: Mark-ups, net of cancellations (xx) (xx)  
COGAS under CONSERVATIVE/LCA   xx  
   xx  / xx / x% Cost rate under Lower of
Cost or Average
      (Conservative)
       
Less: Mark – downs, net of cancellations     x% Cost rate under Average
 (xx)
COGAS under AVERAGE APPROACH xx ^
   
    Retail
Gross Sales xx / xx
 
Less: Sales Return   (xx)
Add: Special Discounts (Employee Disc)   xx
Normal Spoilage/Breakages/Shoplifting losses  
Sales/ Cost of Sales at Retail xx
xx ^^

 
*For FIFO Average, simply disregard in the computation the cost of the beginning inventories:
 
COST % = (COGAS @ Cost – Beg Inventory at Cost) / (COGAS @ Retail – Beg Inventory at Retail )
 
or
 
Net Purchases @ Cost / Net Purchases @ Retail
 
FOR INVENTORY VALUATION PROBLEMS
 
Inventory shall be valued at lower of COST or NRV:

1. Cost shall be measured through

2. FIFO/Periodic – the cost shall be computed as: (# Inventory on hand * Cost of latest purchases)
3. FIFO/Perpetual – the computation of cost shall be the same as FIFO/Periodic
4. AVE/Periodic (weighted average): (# of inventory on hand * WA unit Cost)

WA unit Cost = COGAS / # of GAS

4. AVE/Perpetual (moving average): (# of inventory on hand * MA unit Cost)

The average cost is recomputed after every purchase transaction. The last Moving average unit cost (after the last
purchase transaction of the year) shall be used for the computation of the inventory cost at year end.
 

1. Net Realizable value shall be:

2. Finished goods/Merchandise Inventory = Est Selling Price – Est Cost to Sell
3. Work-in-process inventory = Est Selling Price – Est cost to complete – Est cost to sell
4. Raw materials and supplies – The NV of raw materials shall be the current replacement cost (Current Purchase
Price). The same shall be written down only if the finished goods to which they are related to are written down.

 
Notes:

1. The DIRECT WRITE-OFF METHOD is used in instances where the company holds inventories that ae not
relatively the same from year-end to year-end. Thus, there shall be no chances to recover any loss on write-own
for the year. (which is either added to cost of sale or recognized as separate loss in the statement of
comprehensive income)

2. The ALLOWANCE METHOD is used in instances where the company holds inventories that are relatively the
same from one year-end to another. Thus there shall be a possibility of recovery from inventory write-down from
one year, unto the next year. The difference between cost and NRV, where NRV is lower becomes the required
allowance for inventory write-down (similar to allowance for bad debts), to determine how much is the loss during
the period, the increment from the unadjusted balance of the account shall be determined. Thus, if cost is lower
than the NRV, required balance is zero/nil, any unadjusted credit balance of the account shall generally be
recognized as gain from recovery in the income statement (or deducted from cost of sale).

 
 
 

Allowance for Inventory Write-down

Cr. Adjustment for Loss on write-

Dr. Adjustment for Gain on
down for the period (or addition to
Recovery (or reduction from COS)
COS)
  Required ending balance

Presented below is a list of items that may or may not be reported as inventory in a company’s December 31,
balance sheet:
 
Cost of goods out on consignment at another company’s store                                P 2 400 000
Goods sold on instalment basis                                                                                         300 000
Goods in transit purchased FOB shipping point                                                                360 000
Goods in transit purchased FOB destination                                                                     600 000
Cost of goods sold to another company, for which the company has signed
an agreement to repurchase at a set price that covers all costs related to the
inventory                                                                                                                            900 000
Cost of goods sold where large returns are predictable                                                    840 000
Cost of goods in transit sold FOB shipping point                                                               360 000
Freight charges on goods purchased                                                                                240 000
Factory labor costs incurred on goods still unsold                                                             150 000
Interest cost incurred for inventories that are routinely manufactured                             120 000
Costs incurred to advertise goods held for resale                                                               60 000
Materials on hand not yet placed into production                                                           1 050 000
Office Supplies                                                                                                                    30 000
Raw materials on which the company has started production, but which are
not completely processed                                                                                                  840 000
Factory supplies                                                                                                                   60 000
Cost of goods held on consignment from another company                                         1 350 000
Cost identified with units completed but not yet sold                                                         780 000
Cost of goods in transit sold FOB destination                                                        120 000
Temp. Investment in stocks and bonds that will be resold in the near future     1 500 000
 
How much of these items would typically be reported as inventory in the financial statements?
 
Solution:
Cost of goods out on consignment at another company’s store                                P 2 400 000
Goods sold on instalment basis                                                                                         300 000
Goods in transit purchased FOB shipping point                                                                360 000
Goods in transit purchased FOB destination                                                                     600 000
Cost of goods sold to another company, for which the company has signed
an agreement to repurchase at a set price that covers all costs related to the
inventory – Inventory Financing                                                                                     900 000
Cost of goods sold where large returns are predictable                                                    840 000
Cost of goods in transit sold FOB shipping point                                                               360 000
Freight charges on goods purchased                                                                                240 000
Factory labor costs incurred on goods still unsold                                                             150 000
Interest cost incurred for inventories that are routinely manufactured                            120 000
Costs incurred to advertise goods held for resale                                                               60 000
Materials on hand not yet placed into production                                                           1 050 000
Office Supplies                                                                                                                    30 000
Raw materials on which the company has started production, but which are
not completely processed                                                                                                  840 000
Factory supplies                                                                                                                   60 000
Cost of goods held on consignment from another company                                         1 350 000
Cost identified with units completed but not yet sold                                                         780 000
Cost of goods in transit sold FOB destination                                                        120 000
Temp. investment in stocks and bonds that will be resold in the near future     1 500 000
 
How much of these items would typically be reported as inventory in the financial statements?
P6 900 000.00
 
The following accounts were extracted from the unadjusted trial balance of Silang Corp. as of December 31, 2014.
 
Cash                                        963 200
Accounts Receivables            2 254 000
Merchandise Inventory           6 050 000
Accounts Payable                   4 201 000
Accrued Expenses                 60 400
 
During your audit, you discovered that the client held its cash records open even after year end.
 
Audit notes:
Collections for January 2015 of P654 600 were recorded in the December 2014 cash records. The receipts of P360
100 represents cash sales with the balance representing collections from customers who paid within the 5% cash
discount period.
 
Accounts Payable of P372 400 was paid in January 2015. The payments on which a P12 400 cash discount has
been taken were included in the December 31, 2014 Check register
 
Merchandise inventory as stated in the trial balance represented the result of the count conducted on December 30,
2014 on inventories on hand. The following information were found to be relevant in your audit of inventories:
 
Goods Valued at P275 000 are on consignment with a customer and were not included in the physical count
 
Goods Costing P217 500 were received from a vendor on January 4, 2015. The related invoice was received and
recorded on January 6, 2015. These goods were shipped by the vendor on December 31, 2014 under an FOB
shipping point terms.
 
Goods costing P637 500 were shipped on December 31, 2014, and were received by the customer on January 2,
2015. The terms of the invoice were FOB Shipping Point. The sales of P815 000 has been recorded in 2014.
 
A shipment of goods invoiced at P182 000 to a customer on December 29, terms FOB destination was recorded in
2015. The cost of the related goods amounted to P130 000 and were received by the customers on January 4, 2015.
 
The invoice for goods costing P175 000 was received and recorded as purchase on December 31, 2014. The related
goods, shipped FOB Destination were received on January 4, 2015.
 
Goods valued at P612 00 are on consignment from a vendor. These goods were excluded from the physical count.
 
Based on the result of your audit, ascertain the following:
Adjusted balance of Cash
Adjusted balance of Accounts receivable
Correct Inventory ending balance
Net adjustment to cost of sales
Adjusted accounts payable
 
Solution:
Audit notes:

1. Collections for January 2015 of P654 600 were recorded in the December 2014 cash records. The receipts of
P360 100 represents cash sales with the balance representing collections from customers who paid within the 5%
cash discount period.

 
Cash -654 600
AR -310 000
 

2015. Accounts Payable of P372 400 was paid in January 2015. The payments on which a P12 400 cash discount
has been taken were included in the December 31, 2014 Check register
 
Cash +360 000
AP +360 000 + 12 400
 

1. Merchandise inventory as stated in the trial balance represented the result of the count conducted on December
30, 2014 on inventories on hand. The following information were found to be relevant in your audit of inventories:

 
Goods Valued at P275 000 are on consignment with a customer and were not included in the physical count
 
Inventory +275 000
 
Goods Costing P217 500 were received from a vendor on January 4, 2015. The related invoice was received and
recorded on January 6, 2015. These goods were shipped by the vendor on December 31, 2014 under an FOB
shipping point terms.
 
Inventory +217 500
 
Goods costing P637 500 were shipped on December 31, 2014, and were received by the customer on January 2,
2015. The terms of the invoice were FOB Shipping Point. The sales of P815 000 has been recorded in 2014.
 
Inventory -637 500
 
A shipment of goods invoiced at P182 000 to a customer on December 29, terms FOB destination was recorded in
2015. The cost of the related goods amounted to P130 000 and were received by the customers on January 4, 2015.
 
Inventory +130 000
 
The invoice for goods costing P175 000 was received and recorded as purchase on December 31, 2014. The related
goods, shipped FOB Destination were received on January 4, 2015.
 
AP -175 000
 
Goods valued at P612 00 are on consignment from a vendor. These goods were excluded from the physical count.
 
Based on the result of your audit, ascertain the following:
Adjusted balance of Cash 668 600
Adjusted balance of Accounts receivable 2 564 000
Correct Inventory ending balance 6 035 000
Net adjustment to cost of sales debit by 57 500
Adjusted accounts payable 4 615 900
 
You are making an audit of the MALAGA Co. for the year ended December 31, 2014. You have observed the taking
of physical inventory and have noted that all merchandise actually received up to the close of business, December
28, 2014, were included on the inventory sheets. The total of the physical inventory, at invoice cost, is P175 000,
while the purchase account shows a balance of P 1 750 000 as of December 31, 2014.
 
You note also the following purchase invoices have been recorded in the voucher register as follows:

RR. NO. 12/14 Voucher Invoice Date Terms Merchandise

  Register     Received

631 P2 000 12.26 Shipping Point 12.29

632 4 000 12.26 Destination 1.5

633 9 000 1.2 Destination 12.30

634 8 000 12.31 Shipping Point 1.4

635 1 000 1.7 Shipping Point 12.28
636 6 000 1.3 Shipping Point 1.6

 
RR. NO. 01/15 Voucher Invoice Date Terms Merchandise
  Register     Received

637 P 8 500 12.20 Destination 1.8

638 7 200 1.2 Shipping Point 12.27

639 11 700 12.28 Destination 1.7

640 6 900 12.30 Destination 1.6

641 4 100 1.2 Destination 12.25

 
What is the adjusted balance of Purchases for the period ended December 31, 2014?
What is the adjusted balance of the Inventory account as of December 31, 2014?
 
Solution:
 

RR. 12/14 Invoic Terms Merchandise Inv Purch

NO. Voucher e Date Received
Register      
     
       
631 12.26 12.29
Shipping Point + /
 P2 000
632 12.26 Destination 1.5 / -
4 000
633 1.2 Destination 12.30 + /
9 000
634 12.31 Shipping Point 1.4 + /
8 000
635 1.7 Shipping Point 12.28 / /
1 000
636 1.3 Shipping Point 1.6 / -
6 000

01/15
RR. Invoic Terms Merchandise Inv Purch
Voucher
NO. e Date   Received    
Register
           
 
637 12.20 Destination 1.8 / -
P 8 500
638 1.2 Shipping Point 12.27 / +
7 200
639 12.28 Destination 1.7 / /
11 700
640 12.30 Destination 1.6 / /
6 900
641 1.2 Destination 12.25 / +
4 100

 
What is the adjusted balance of Purchases for the period ended December 31, 2014? 1 751 300
What is the adjusted balance of the Inventory account as of December 31, 2014? 194 000
 
You were assigned to test the reasonableness of the inventory account balance as reported by your client, Surely
Corp. The following information is made available by Surely Corp’s Accountant:
 

  Cost Retail
Beginning Inventory P598 400 P1 500 000
Purchases 3 048 400 5 500 000
Freight In 80 000  
Purchase Returns 140 000 180 000
Mark-ups 600 000
Mark-up cancellation 100 000
Mark-downs 1 300 000
Mark-down cancellation 385 000
Sales 4 470 000
Sales returns 150 000
Sales discount 200 000
Employee discount 400 000

 
Ending Inventory as a result of the physical count conducted on December 31, was at P649 600. What is the amount
of estimated inventory shortage, if any, as a result of your test of reasonableness under the following assumed
formula?
 
Lower of cost or average/Conservative/Conventional Approach
Average Approach
FIFO Retail Approach
 
Solution:
(Refer to the discussion part of this module for additional reference)
 
 

    Cost Retail
Beginning Inventory   P598 400 P1 500 000
Purchases   3 048 400 5 500 000
 80 000
Freight In  
140 000
Purchase Returns 180 000
 
Mark-ups 600 000
 
Mark-up cancellation 100 000
 
Mark-downs   1 300 000
TGAS 6 405
Mark-down TGAS 3 586 000 385 000
cancellation 800
  4 470 000
Sales
  150 000
Sales returns
  200 000
Sales discount
4 720 000 400 000 + to
Employee discount Sales
1 685 000

 
Lower of cost or average/Conservative/Conventional Approach 176 050
TGAS @ COST / (TGAS @ RET + NET MD) = 49%
 
Average Approach 294 000
TGAS @ COST / TGAS @ RET = 56%
 
FIFO Retail Approach 378 250
(TGAS @ COST – B.I. @ COST) / (TGAS @ RET – B.I. @ RET) = 61%
 
On May 31, 2014, a fire completely destroyed the work-in-process inventory of Alder Paints. Physical inventory were
published as follows:
 

  As of January 1, 2014 As of May 31, 2014

Raw Materials 15000 30000
Work-in-process 50000 -
Finished Goods 70000 60000

 
Sales for the first five months of 2014 were 150 000. Raw materials purchased were 50 000. Freight on purchases
was 5 000. Direct labor for the five months was 40 000. To determine the value of the lost inventory, the insurance
adjusters have agreed to use an average gross profit rate of 32.5%. Assume that the manufacturing overhead was
45% of direct labor cost.
 
How much is the value of the goods manufactured and completed as of May 31, 2014?
Raw materials used during the first five months of 2014 were?
The total value of the goods put into process during the five-month period amounted to?
The value of the destroyed work-in-process inventory as determined by the insurance adjusters
would be?
 
Solution:
 
Raw Materials, beg                            15       
Purchases                                           50
Freight-In                                             5
Raw Materials available for use         70
Raw Materials, end                             (30)
Raw Materials, used                           40
Direct Labor                                        40
Overhead                                            18 (45% of DL)
Total manufacturing cost                    98      
Work-in-Process, beg                         50
Total goods in process                        148
Work-in-Process, end                         (56.75)
Total goods manufactured                  91.25
Finished goods, beg                            70
Total goods available for sale             161.25
Finished goods, end                            (60)
Cost of goods sold                              101.25 (100% - 32.5%) of sales
 
How much is the value of the goods manufactured and completed as of May 31, 2014? 91 250
Raw materials used during the first five months of 2014 were? 40 000
The total value of the goods put into process during the five-month period amounted to? 148 000
The value of the destroyed work-in-process inventory as determined by the insurance adjusters
would be? 56 750
 
On May 21, 2014, a fire destroyed the entire merchandise inventory on hand of Natural Corporation. The following
information is available:
 

Sales, January 1 through May 2, 2014                380 000

Sales return covering the same period 20 000
Sales allowance covering the same period 10 000
Sales discounts covering the same period 25 000
Inventory, January 1, 2014 80 000
Purchases, January 1 through May 2, 2014 (including 40 000  
of goods in transit on May 2, 2014 shipped FOB shipping
point) 400 000

Purchase discounts 40 000

Purchase returns and allowances 30 000

Mark-up percentage on cost 20%

 
What is the estimated inventory on May 2, 2014 immediately prior to fire?
How much should be recognized as inventory loss?
 
 
Solution:
 
Net Sales (120%)                                                        360 000
Cost of Sales (100%)                                                  (300 000)
Gross Profit (20%) based on cost                               60 000
 
Merchandise Inventory, Beginning                            80 000
Purchases                                                                   330 000
Merchandise Inventory, Ending                              (110 000)
Cost of Sales (360 000 x 20/120)                             300 000
 
Merchandise Inventory, Ending                                  110 000
Goods in Transit                                                          ( 40 000)
Inventory Loss                                                                  70 000
 
What is the estimated inventory on May 2, 2014 immediately prior to fire? 110 000
How much should be recognized as inventory loss? 70 000

AUDIT PROCEDURES

1. Obtain a list of aged accounts receivable balances from the subsidiary ledger, and:

 Foot and cross-foot the list

 Check if the list reconciles with the general ledger control account
 Trace individual balances to the subsidiary ledger
 Test the accuracy of the aging
 Adjust non-trade accounts erroneously included in customers’ accounts
 Investigate and reclassify significant credit balances

2. Test accuracy of balances appearing in the subsidiary ledger

3. Confirm accuracy of individual balances by direct communication with customers

 Investigate exceptions reported by customers and discuss with appropriate officer for proper disposal
 Send a second request for positive confirmation requests without any replies from customers
 If the second request does not produce a reply from the customer, perform extended procedures, like:

 
Reviewing collections after year-end
Checking supporting documents
Discussing the account with appropriate officer
 

 Discuss with appropriate officer, confirmation requests returned by the post office and perform extended
procedures.
 Prepare a summary of confirmation results.

4. Review correspondence with customers for possible adjustments.

5. Test propriety of cutoff:

 Examine sales recorded and shipments made a week before and after the end of the reporting period and
ascertain whether the sales were recorded in the proper period.
 Investigate large amounts of sales returned shortly after the end of the reporting period.
6. Perform analytical procedures, like:

 Gross profit ratio

 accounts receivable turnover
 ratio of accounts written off to sales or balance of accounts receivable
 compare with prior year and industry averages

7. Review individual balances and age of accounts with appropriate officer, and:

 determine accounts that should be written off

 determine adequacy of allowance for doubtful accounts

8. Obtain analyses of significant other receivables

9. Ascertain whether some receivables are pledged, factored, discounted or assigned.
10. Determine financial statement presentation and adequacy of disclosures
11. Obtain receivable representation letter from client.

NOTES FOR AGING OF ACCOUNTS RECEIVABLE PROBLEMS:

 

 The aging schedule should be based on and should agree with the subsidiary ledger.
 The aging schedule should be adjusted first with all possible adjustments before a required allowance is
computed. Possible adjustments include:

1. Adjustment to both the GL and SL (thus Aging)

o additional write-off accounts
o unrecorded sale/over recorded sale; unrecorded collections
o credit balance in accounts receivable (adjusted to advances from customers)
2. Adjustment to SL only (no adjusting entry required, but Aging schedule may be adjusted)
 o sales/collections already recorded in the GL but not yet in the SL
o posting errors
3. Adjustment to GL only – will not affect the Aging schedule anymore (e.g. sales/collections not yet recorded by the
GL but already posted to the SL)

 The adjusted balance of the subsidiary ledger shall ultimately be the correct/adjusted balance of the accounts
receivable gross of the required allowance
 If the general ledger ultimately does not coincide or equal to the subsidiary ledger, an additional adjustment
should be in place to correct the general ledger to equal the Adjusted Balance of the subsidiary ledger. The
adjustment is either debited or credited to SALES account.
 To compute for the Bad Debt Expense for the period, the adjusted balance per computation is compared to the
unadjusted balance. (Do not forget to consider write-off of accounts receivable, recoveries of previously written-off
accounts and interim bad debt provisions, if there are any):

 
Allowance for Bad Debt Expense

Beginning Balance
Dr: Write-off Receivables (including
Cr: Recovery of Previous Write-off
additional write-off per audit)
Cr: Bad Debt Expense (Squeeze)

  Required Ending Balance

 
FOR LOANS RECEIVABLE PROBLEMS (SIMILAR TO FINANCIAL ASSET AT AMORTIZED COST)
INITIAL MEASUREMENT:
Initial measurement of loans receivable shall be fair at market value, which shall be the net initial investment or the
net cash given-up on the loan transaction. More specifically, the net initial investment shall be:
 

Principal amount of the loan xx

Add: Origination costs* xx
Less: Origination fees** (xx)
FMV of the loan/Initial investment xx

 
*Origination costs are costs that are directly attributed to the loan transaction such as brokers’ fees and
commissions, prof. fees (e.g. lawyers for drafting debt agreements or to accountants for assessment of any asset
collateral on the loan).
**Origination fees  are origination costs chargeable to the debtor as per the debt agreement. It can be an amount
higher or lower than the actual origination cost incurred.
 
BALANCE SHEET MEASUREMENT
Loans receivable shall be measured at the balance sheet date at amortized cost, which shall be:
 
Initial amount recognized/FMV at initial
xx
recognition
(xx)
Less: Principal collections
xx
Less: Amortization of premium on loan or
(xx)
Add: Amortization of discount on loan
(xx)
Less: Impairment loss*, if any
xx
Amortized cost

 
*IMPAIRMENT LOSS OF LOANS RECEIVABLE

Carrying value of the Loans and Receivable**

xx
 
 
Less: Present value of expected cash to be
recovered             using the ORIGINAL EFFECTIVE  
INTEREST RATE
(xx)
 
 
Impairment Loss/Bad Debt Expense
xx
            **include accrued interest as a general rule
In the course of your audit of         ABCD Company’s “Receivables” account of December 31, 2014, you found out
that the account comprised the following items:    
           
Trade accounts receivable                                                                       1 550 000     
Trade accounts receivable, assigned     
(Proceeds from assignment amounted to 650000)                               750 000                                             
Trade accounts receivable, factored       
(Proceeds from factoring                                                                           300 000         
Done on a without recourse basis amounted to                                      250 000         
12% Trade notes receivable                                                                      200 000         
20% Trade notes receivable, discounted at 40% upon
      receipt of the 180 day note on a without recourse basis                300 000         
Trade receivables rendered worthless                                                     50 000           
Installments receivable, normally due 1 year to 2 years                       600 000         
Customers’ accounts reporting credit balances arising from               60 000           
      sales returns      
 Advance payments for purchase of merchandise                                 300 000         
Customers’ accounts reporting credit balances arising from
advance payments                                                                                     40 000                             
Cash advances to subsidiary                                                                    800 000         
Claim from insurance company                                                                30 000           
Subscription receivable due in 60 days                                                  600 000         
Accrued interest receivable                                                                       20 000           
Deposit on contract bids                                                                            500 000         
Advances to stockholders (collectible in 2017)                                      2 000 000     
           
How much is the total trade receivables?           
How much is the amount to be presented as “trade and other receivables” under current assets?
How much loss from receivable financing should be recognized in the income statements?    
           
           

 
SOLUTION:                                                                                                              
Trade  CA     
Trade accounts receivable 1550 000 /          

Trade accounts receivable, assigned      (proceeds from            assignment amounted

750 000 /            
to 650 000)          

Trade accounts receivable, factored (proceeds from     factoring        Done on a without

300 000                        
recourse basis amounted to 250000

12% Trade notes receivable                                                                      200 000 /            

20% Trade notes receivable, discounted at 40% upon receipt            of the 180 day
300 000    
note on a without recourse basis

   

Trade receivables rendered worthless                                         50 000    

Installments receivable, normally due 1 year     to 2 years              600 000 /            

Customers’ accounts reporting credit balances arising            from Sales returns   60 000    

Advance payments for purchase of merchandise                                 300 000   /          

Customers’ accounts reporting credit balances arising            from Advance 40 000    

payments    

Cash advances        to subsidiary                                                            800 000    

Claim from insurance company                                        30 000             /          

Subscription receivable due in 60 days                          600 000             /          

Accrued interest receivable                                                           20 000             /          

Deposit on contract bids                                                     500 000    

Advances to stockholders (collectible in 2017)              2000 000    

 
How much is the total trade receivables?                                    3 100 000     
How much is the amount to be presented as “trade and other receivables” under current assets?
4 050 000                 
 
Proceeds from AR factored                                                            250 000         
Carrying value of AR factored                                                       (300 000)      
Loss from factoring                                                                          (50 000)                                                        
Proceeds from NR discounted:                
Maturity value (principal + interest)                                 
Principal                                                                                            300 000         
Interest (300 000 * 20% * 6/13)                                                      30 000
                                                                                                            330 000         
Less: Discount (MV*disc%*remaining term)                               (66 000)
                        (330 000*40%*6/12)           
Proceeds from NR discounted:                                                     264 000
Carrying value of NR (no interest)                                                            300 000
Loss from discounting i8                                                                (36 000)
Total loss from receivable financing                                            (86 000)                    
 
How much loss from receivable financing should be recognized in the income statements?    
86 000           
 
In relation to your audit of Phish Inc.’s accounts receivable, you ascertained the following information:           
The general ledger balances of the client’s receivable and accounts were:           
            Accounts receivable                                    3 225 300     
            Allowance for bad debts                 (169 000)      
            Amortized Cost                                 3 056 300     
 
Phish estimates its bad debt losses by aging its accounts receivable, the aging schedule of accounts           
receivable at December 31, 2014, is presented below:
           
            Age of accounts                                           Amount         
            Current                                                          1 686 400     
            1 to 30 days past due                                  922 000         
            31 to 60 days past due                                384 800         
            61 to 90 days past due                                153 300         
            Over 90 days past due                                78 800           
           
The company normally sells n/30.           
Furthermore, the company’s uncollectible accounts experience for the past years is summarized in the           
schedule that follows:        
           
            Year    Current   1-30 days PD   31-60 days PD   61-90 days PD   More than 90 days PD
            2013   1%                  6%                  9%                    23%                 55%           
            2012   2%                  8%                  10%                  18%                 60%           
            2011   1%                  4%                  11%                  16%                  45%           
            2010   3%                  5%                  12%                  22%                  45%           
            2009   3%                  2%                  8%                    21%                 45%           
           
The required allowance for bad debts is?          
The net realizable value of the company’s accounts receivable on December 31, 2014, should be?   
           
SOLUTION:              
The required allowance for bad debts is?          
           
            Year    Current   1-30 days PD   31-60 days PD   61-90daysPD   More than 90 days PD  
            2013   1%                  6%                  9%                    23%                   55%          
            2012   2%                  8%                  10%                  18%                   60%          
            2011   1%                  4%                  11%                  16%                   45%          
            2010   3%                  5%                  12%                  22%                   45%          
            2009   3%                  2%                  8%                    21%                   45%          
            Ave     2%                  5%                  10%                  20%                   50%          
            AR      1 686 400      922 000          384 800            153 300             78 800      
Req. Allow     33 728            46 100            38 480              30 660               39400 = 188 368
           
The net realizable value of the company’s accounts receivable on December 31, 2014, should be?   
Gross Accounts Receivable                                              3 225 300     
Allowance for Uncollectible Accounts                             (188 368)      
Amortized cost/ Net realizable value                                3 036 932     
           
You are auditing the Accounts Receivable of Rovers Inc. as of December 31, 2014.  You found the            following
information in the general journal:     
           
Accounts Receivable                                              1 466 720     
Less: Allowance for doubtful accounts               (46 720)        
Accounts receivable net                                         1 420 000     
           
The accounts receivable subsidiary ledger had the following details:         
Customer       Invoice           Date    Amount          Balance           

Gee                 9/12/2014      139 200          139 200

Tee                 12/12/2014    153 600           

                        12/02/2014    99 200                        252 800

Geo                 11/17/2014    185 120           

                        10/08/2014    176 000          361 120

Nee                 12/08/2014    160 000           

                        10/25/2014    44 800             

                        8/20/2014      40 000                        24 480

Neo                 9/27/2014      96 000                        96 000

Bee                 8/20/2014      71 360                        71 360

Pee                 12/06/2014    112 000           

                        11/29/2014    169 440          281 440

Total                                                               1 446 720           

Additional Information:      
You discovered based on review of subsequent events that Bee recently went bankrupt, thus you suggested that the
amount receivable from the same shall be written off.          
You also discovered that the invoice dated 12/02/2014 has already been settled by Tee per OR number        34675.
The amount however has been erroneously posted against Geo’s subsidiary ledger as a        settlement for an
invoice dated 11/05/2014 for the same amount.    
The estimated bad debts rates below are based on the company’s receivable collection experience:  
           

Age of accounts                   % of Collectibility

0-30 days                               98%   

31-60 days                            95%   

61-90 days                            90%   

91-120 days                          80%   

over 120 days                                   50%   

           
Assuming that there were no entries to the allowance for doubtful accounts, what is the corrected bad debts expense
for the year?   
What is the correct allowance for bad debts expense for the year ended December 31, 2014?  
What is the net adjustment to the Accounts receivable in the general ledger?      
What is the carrying value of the company’s accounts receivable as of December 31, 2014?    
What is the necessary adjusting entry to adjust any difference between the SL and GL?           
           
SOLUTION:  
           

Customer       Invoice Date  Amount            Age    

Gee                 9/12/2014      139 200 91-120 days 

Tee                 12/12/2014    153 600 0-30 days

                        12/02/2014    99 200 0-30 days                  

Geo                 11/17/2014    185 120 31-60 days   

                        10/08/2014    176 000 61-90 days   

Nee                 12/08/2014    160 000 0-30 days      

                        10/25/2014    44 800 61-90 days   

                        8/20/2014      40 000 more than 120 days

Neo                 9/27/2014      96 000 91-120 days 

Bee                 8/20/2014      71 360 more than 120 days

12/06/2014 112 000 0-30 days      

Pee                
11/29/2014 169 440 31-60 days

Total:              1 446 720            

 
 
Reconciliation between GL and SL with Aging of AR analysis

0-30 31-60 61-90 91-120

  Per GL Per SL >120 days
days days days days
 1 466
Unadjusted balances 1 466
720 524 800 354 560 111 360
720
(a) Write-off of AR-
(71     220 800 235 200 (71 360)
Balong (71 360)
360)
(99200) 99 200  
(b) Posting error -
-

Adjusted Balances 1 395

360 1 375
Unreconciled 425 600 453 760 220 800 235 200 40 000
360
difference (20000)

1 375
Adjusted balance            
360

Required allowance
               2% 5% 10% 20% 50%
for BD in %

Required allowance
  120 320 8 512 22 688 22 080 47 040 20 000
for BD in amount

120
Allowance for BD
320
 (46
Less: Allowance for BD, unadjusted
720)

Add: Write-off of AR-Balong 71 360

144
Bad Debt Expense
960

Write-off of AR-Balong (71 360)

Unlocated difference (debited to Sales) (20 000)

Total adjustments to AR-GL (91 360)

1 375
Gross Accounts Receivables
360

(120
Allowance for Bad Debts
320)
 1 255
Amortized cost/Carrying value
040

AJE to record unreconciled difference:    

Sales 20 000  

     Accounts receivable   20 000

 
On December 31, 2013, ISIAH Company, a financing institution lent P4 000 000 to PSALMS Corp. due 3 years after.
The loan is supported by an 8% note receivable. Transaction cost incurred to originate the loan amounted to P248
000. P374 000 was chargeable to Psalms as origination fee. Interest on the loan is collectible at the end of each
year. The yield rate on the loan is 9.25%.
Isiah was able to collect interest as it became due at the end of 2014. During 2015, however, due to Psalms
Corporation’s business deterioration and due to political instability and faltering global economy, the company was
not able to collect amounts due at the end 2015. After reviewing all available evidence at December 31, 2015, Isiah
Company determined that it was probable that Psalms would pay back only P3 400 000 collectible as follows

December 31, 2017 P1 400 000

December 31, 2018 1 000 000

December 31, 2019 600 000

December 31, 2020 400 000

 
As of December 31, 2015, the prevailing rate of interest for all debt instruments is 14%.
SOLUTIONS:

Principal amount 4 000 000

Add: Origination cost 248 000

Less: Origination fees (374 000)

Initial amount/ Fair value/Proceeds 3 874 000

 
Based on the above information and on your audit, answer the following requirements:

1. What is the carrying value of the loans receivables as of December 31, 2014?
Amortization table: Loans receivable

Correct Int. Nominal Int. Amortization Balance

December 31, 2013 3 874 000

December 31, 2014 358 345 320 000 38 345 3 912 345

December 31, 2015 361 892 320 000 41 892 3 954 237

December 31, 2016 365 763 320 000 45 763 4 000 000

2. What is the impairment loss to be recognized in the 2015 statement of comprehensive income?

Amortized cost/Carrying value (12/31/15) 3 954 237

Accrued interest (12/31/15) 320 000

Total receivable (12/31/15) 4 274 237

Less: Present value of new future cash flows at 9.25%

      Due 12/31/2017: (1.4M*0.837832) 1 172 965

      Due 12/31/2018: (P1M*0.766895) 766 895

      Due 12/31/2019: (P600K*0.701963) 421 178

      Due 12/31/2020: (P400K*0.642529) 257 012 2 618 049

1 656 188

3. What is the interest income to be recognized in the 2017 statement of comprehensive income?
4. What is the correct carrying value of the loans receivable as of December 31, 2017?

Amortization table: Loans receivable after impairment loss

Correct Int. Nominal Int. Amortization Principal Coll. Balance

December 31, 2015 2 618 049

December 31, 2016 242 170 - 242 170 - 2 860 219

December 31, 2017 264 570 - 264 570 1 400 000 1 724 789

December 31 2018 159 543 - 159 543 1 000 000 884 332

December 31, 2019 81 801 - 81 801 600 000 366 133

December 31, 2020 33 867 - 33 867 400 000 0

 
 
 
Visage Corp. had the following receivable financing transactions during the year:

 On March 1, 2014, Visage Corp. factored P500 000 of its accounts receivables to BPI. as of the date of factoring,
it was ascertained that P20 000 of the accounts receivable is doubtful of collection. CPI advanced P350 000 cash
to Visage Corp. and withheld P50 000 as factors holdback (to cover future sales discount and sales returns and
allowances). The company incurred P10 000 direct transaction costs (legal fees and other professional fees)
related to the factoring. The factoring was done on a without-recourse bases, thus transferring all significant risks
and rewards associated to the receivable to BPI.

 On May 1, 2014, Visage Corp. assigned P800 000 of its outstanding accounts receivable to BPI in consideration
of a P500 000, 24% loan. BPI charged the company 2% of the accounts assigned as service charge. By the end
of May, Visage Corp. collected P200 000 cash from the assigned accounts after P4 000 sales discount. The
 company accepted merchandise originally invoiced at P30 000 as sales returns and wrote-off P20 000 of the
assigned accounts as worthless. It was agreed between parties that monthly collections shall be remitted in the
bank as partial payment of the loan and interest.

 On July 1, 2014, Visage Corp. accepted from a customer a 6-month P600 000, 12% notes receivable for the sale
of merchandise. On October 31, 2014, Visage Corp. discounted the note to BPI at a discount rate of 10%. The
discounting done on a without-recourse basis, thus transferring all significant risks and rewards associated to the
receivable to BPI.

SOLUTIONS:

1. How much should be reported as gain/loss in the income statement on the transfer of receivables on the factoring
of receivable on March 1?

Net cash proceeds from factoring (P350 000-P10 000) 340 000

Factors holdback 50 000

Total/Net sales price of AR factored 390 000

Less: Carrying value of AR (P500 000-P20 000) (480 000)

Loss from factoring (90 000)

 

2. How much should be reported as gain/loss in the income statement on the transfer of receivables on the
assignment of receivable on May1?

Assignment is only a loan transaction, thus there is no transfer if receivable.

3. What is the carrying value of the accounts receivable-assigned as of June 30?

Accounts receivable-assigned 800 000

May collections with sales discount (P200 000+P5 000) (205 000)

June collection with sales discount (P150 000+P4 000) (154 000)

Sales returns (30 000)

Accounts written-off as worthless (20 000)

Accounts receivable-assigned - June 30 391 000

4. What is the carrying value of the loans payable related to the accounts receivable assigned as of June 30?
 5.
Payment Interest Principal Balance

(Bal*24%*1/: (Payment-Int)

Loans payable balance, May 1 500 000

May 31 remittance 200 000 10 000 190 000 310 000

June 31 remittance 150 000 6 200 143 800 166 200

5. How much should be reported as gain/loss in the income statement on the transfer of receivables on the
discounting of the note receivable on July 1?

Proceeds from discounting ** 625 400

Less: Carrying value of Notes (600 000)

       Interest receivable up to Oct. 31 (P600K*12%*4/12) (24 000)

Gain on Discounting 1 400