Auditing

Easy

1. Which of the following would be least likely to be consideredan audit planning procedure?

a. Use an engagement letter.

b. Develop the overall audit strategy.
c. Perform risk assessment.
d. Develop the audit plan.

Answer: C

Performing the risk assessment occurs subsequentto audit planning.

2. A successor auditor should request the new client to authorizethe predecessor auditor to allow a
review of the predecessor’s
Engagement letter Working papers
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer: C

The requirement is to determine whether a successorauditor should request a new client to authorize the
predecessorauditor to allow a review of the predecessor’s engagementletter, working papers, or both.
Answer c is correctbecause standard states that it is advisable that a successorauditor request to be
allowed to review the predecessor’s workingpapers.

3. Professional skepticism requires that an auditor assume thatmanagement is

a. Honest, in the absence of fraud risk factors.

b. Dishonest until completion of audit tests.
c. Neither honest nor dishonest.
d. Offering reasonable assurance of honesty

Answer: C

Professional skepticismrequires that an auditor neither assume dishonesty nor unquestioned

honesty.

4. Which of the following most likely would not be considerean inherent limitation of the potential
effectiveness of an entity’sinternal control?

a. Incompatible duties.
b. Management override.
c. Mistakes in judgment.
d. Collusion among employees.

Answer: A

The requirement is to identify the reply that mostlikely would not be considered an inherent limitation of
the potentialeffectiveness of an entity’s internal control. Answer A is correct because incompatible duties
may generally be dividedamong individuals in such a manner as to control the problem.
 5. Which of the following is not a component of an entity’sinternal control?

a. Control risk.
b. Control activities.
c. Monitoring.
d. Control environment.

Answer: A

While auditors assess control risk as a part of their considerationof internal control, it is not a component
of an entity’sinternal control.

6. To obtain audit evidence about control risk, an auditor selectstests from a variety of techniques
including

a. Inquiry.
b. Analytical procedures.
c. Calculation.
d. Confirmation.

Answer: A

Auditors test controls to provide evidencefor their assessment of control risk through inquiries
ofappropriate personnel, inspection of documents and records,observation of the application of controls,
and reperformance ofthe application of the policy or procedure.

7. Which of the following is not an assertion relating to classesof transactions?

a. Accuracy.
b. Consistency.
c. Cutoff.
d. Occurrence.

Answer: B

The assertions for classesof transactions are occurrence, completeness, accuracy, cutoffand
classification.

8. Operational auditing is primarily oriented toward

a. Future improvements to accomplish the goals of management.

b. The accuracy of data reflected in management’s financial
records.
c. The verification that a company’s financial statements
are fairly presented.
d. Past protection provided by existing internal control.

Answer: A

Operational audits deal primarilywith evaluating the efficiency and effectiveness with which operations
function, often with the intention of making improvementsto accomplish the goals of management.
 9. Which of the following types of evidence would an auditormost likely examine to determine
whether controls are operatingas designed?

a. Confirmations of receivables verifying account balances.

b. Letters of representations corroborating inventory
pricing.
c. Attorneys’ responses to the auditor’s inquiries.
d. Client records documenting the use of computer programs.

Answer: D

Inspection of client records documenting the use of computerprograms will provide evidence to help the
auditor evaluate theeffectiveness of the design and operation of internal control; the client’s control over
use of its computer programs in this case isdocumentation of the use of the programs. In order to test
thiscontrol, the auditor will inspect the documentation records.

10. A procedure that involves tracing a transaction from itsorigination through the company’s
information systems until it isreflected in the company’s financial report is referred to as a(n)

a. Analytical analysis.
b. Substantive procedure.
c. Test of a control.
d. Walk-through.

Answer: D

Walk-through is a procedure thatinvolves tracing a transaction from origination through the

company’sinformation systems until it is reflected in the company’sfinancial report.

11. Which of the following is an accurate statement about internalcontrol weaknesses?

a. Material weaknesses are also control deficiencies.

b. Significant deficiencies are also material weaknesses.
c. Control deficiencies are also material weaknesses.
d. All control deficiencies must be communicated to theaudit committee.

Answer: A

All material weaknessesare control deficiencies.

12. In an integrated audit, which of the following is defined as aweakness in internal control that is
less severe than a materialweakness but important enough to warrant attention by those
responsible for oversight of the financial reporting function?

a. Control deficiency.
b. Unusual weakness.
c. Unusual deficiency.
d. Significant deficiency.

Answer: D

Significant deficiency is definedas a weakness in internal control that is less severe than a material
weakness but important enough to warrant attention bythose responsible for oversight of the financial
reporting function.
 13. Proper authorization of write-offs of uncollectible accountsshould be approved in which of the
following departments?

a. Accounts receivable.
b. Credit.
c. Accounts payable.
d. Treasurer.

Answer: D

The treasurer’s department is the department responsiblefor bad debt write-offs. It should be
independent of the sales, credit, and the recordkeeping for that function, and shouldhave knowledge
tohelp make proper decisions of this nature.

14. Proper segregation of functional responsibilities calls forseparation of the functions of

a. Authorization, execution, and payment.

b. Authorization, recording, and custody.
c. Custody, execution, and reporting.
d. Authorization, payment, and recording.

Answer: B

Authorizing transactions, recording transactions,and maintaining custody of assets should be segregated.

15. Relationship between control risk and detection risk is ordinarily

a. Parallel.
b. Inverse.
c. Direct.
d. Equal.

Answer: B

Control risk and detection risk has an inverse relationship with each other. As control risk increases
(decreases) detection risk mustdecrease (increase).

Average

1. As the acceptable level of detection risk decreases, the assurance directly provided from

a. Substantive tests should increase.

b. Substantive tests should decrease.
c. Tests of controls should increase.
d. Tests of controls should decrease.

Answer A

The requirement is to identify an effect of a decrease in the acceptable level of detection risk. Answer (a)
is correct because as the acceptable level of detection risk decreases, the assurance provided from
substantive tests should increase. To gain this increased assurance the auditors may (1) change the
nature of substantive tests to more effective procedures (e.g., use independent parties outside the entity
rather than those within the entity), (2) change the timing of substantive tests (e.g., per form them at
year-end rather than at an interim date), and (3) change the extent of substantive tests (e.g., take a larger
sample). Answer (b) is incorrect because the assurance provided from substantive tests increases, it
does not decrease. Answers (c) and (d) are incorrect because the acceptable level of detection risk is
based largely on the assessed levels of control risk and inherent risk. Accordingly, any tests of controls
will already have been performed.

2. According to the standards of the profession, which of the following activities would most likely not
impair a CPA’s independence?

A. Providing advisory services for a client.

B. Contracting with a client to supervise the client’s office personnel
C. Signing a client’s checks in emergency situations.
D. Accepting a luxurious gift from a client.

Answer A

The requirement is to determine the activity that would most likely not impair a CPA’s independence.
Accounting and consulting services do not normally impair independence because the member’s role is
advisory in nature. Answers (b) and (c) are incorrect because management functions are being
performed. Answer (d) is incorrect because accepting a luxurious gift impairs a CPA’s independence.

3. The bank statement for December 2017 contains the following data:

Total deposits P110,000

Total charges. including an NSF check of P8,000 and a

service charge of P400 96,000

All outstanding checks on November 30, 2017, including the bank credit, were cleared in the bank
in December 2017.
There were outstanding checks of P30,000 and deposits in transit of P38,000 on December 31, 2017.

How much is the cash balance per bank on December 31, 2017?

a. P154,000 c. P164,000

b. P150.000 d. P172,400

Answer: C

Balance per bank, Nov. 30, 2006 P 150,000

Add: Total deposits per bank statement 110,000
Total 260,000
Less: Total charges per bank statement 96,000
Balance per bank, Dec. 31, 2006 P164,000

4. The management of a client company believes that the statement of cash flow is not a useful document
and refuses to include one in the annual report to stockholders. As a result, the auditor's opinion should
be

a. Qualified due to inadequate disclosure.

 b. Qualified due to a scope limitation.
c. Adverse.
d. Unqualified.

Answer A

A management that refuses to include one in the annual report to stockholders would result to a qualified
opinion due to inadequate disclosure

5. An auditor would issue an adverse opinion if

a. The audit was begun by other independent auditors who withdrew from the engagement.
b. A qualified opinion cannot be given because the auditor lacks independence.
c. The restriction on the scope of the audit was significant.
d. The statements taken as a whole do not fairly present the financial position, results of operations,
and cash flows of the company.
e.
Answer D.
An auditor would issue an adverse opinion if the statements taken as a whole do not fairly present the
financial position, results of operations, and cash flows of the company.

6. The fourth reporting standard requires that the auditor's report contain either an expression of opinion
regarding the financial statements taken as a whole or an assertion that an opinion cannot be
expressed. The objective of the fourth standard is to prevent

a. An auditor from reporting on one basic financial statement and not the others.
b. An auditor from expressing different opinions on each of the basic financial statements.
c. Management from reducing its responsibility for the basic financial statements.
d. Misinterpretations about the degree of responsibility the auditor assumes.

Answer: D

The objective of the fourth standard is to prevent misinterpretations about the degree of responsibility the
auditor assumes.

7. An auditor's opinion reads as follows: "In our opinion, except for the above-mentioned limitation on
the scope of our audit...” This is an example of a

a. Review opinion.
b. Emphasis on a matter.
c. Qualified opinion.
d. Unacceptable reporting practice.

Answer: D
“Except for the above-mentioned limitation on the scope of our audit” is unacceptable phrase in reporting
practice

8. An auditor's report includes a statement that "the financial statements do not present fairly the
financial position in conformity with generally accepted accounting principles." This auditor's
report was probably issued in connection with financial statements that were

a. Prepared on a comprehensive basis for accounting other than GAAP.

 b. Restricted for use by management.
c. Misleading.
d. Condensed.
Answer: C
An auditor's report that says "the financial statements do not present fairly the financial position in
conformity with generally accepted accounting principles." was issued in connection with financial
statements that were misleading.

9. If the auditor believes there is minimal likelihood that resolution of an uncertainty will have a material
effect on the financial statements, the auditor would issue a(n)

a. Qualified opinion.
b. Adverse opinion.
c. Unqualified opinion.
d. Disclaimer of opinion.
Answer: C
The auditor would issue an unqualified opinion if a minimal likelihood that resolution of an uncertainty will
have a material effect on the financial statements

10. If an accounting change has no material effect on the financial statements in the current year but the
change is reasonably certain to have a material effect in later years, the change should be

a. Treated as a consistency modification in the auditor's report for the current year.
b. Disclosed in the notes to the financial statements of the current year.
c. Disclosed in the notes to the financial statements and referred to in the auditor's report for the
current year.
d. Treated as a subsequent event.

Answer B
If the change is reasonably certain to have a material effect in later years, the change should be disclosed
in the notes to the financial statements of the current year.

11. In which of the following situations would the auditor appropriately issue a standard unqualified report
with no explanatory paragraph concerning consistency?

a. A change in the method of accounting for specific subsidiaries that comprise the group of
companies for which consolidated statements are presented.
b. A change from an accounting principle that is not generally accepted to one that is generally
accepted.
c. A change in the percentage used to calculate the provision for warranty expense.
d. Correction of a mistake in the application of a generally accepted accounting principle.

Answer: C

A change in the percentage used to calculate the provision for warranty expense would result to a
standard unqualified report with no explanatory paragraph concerning consistency.

12. When financial statements are presented that are not in conformity with generally accepted
accounting principles, an auditor may issue a(n)
 Qualified Adverse
opinion opinion

a. Yes No
b. Yes Yes
c. No Yes
d. No No

Answer B

A qualified or an adverse opinion is issued when the financial statements are not presented in conformity
with generally accounting principles.

13. The tolerable rate of deviation for tests of controls necessary to justify a control risk assessment
depends primarily on which of the following?

a. The cause of errors.

b. The extent of reliance to be placed on the procedures.
c. The amount of any substantive errors.
d. The limit used in audits of similar clients.

Answer B

The tolerable rate of deviation for tests of controls necessary to justify a control risk assessment depends
primarily on the extent of reliance to be placed on the procedures.

14. Which of the following is an element of sampling risk?

a. Choosing an audit procedure that is inconsistent with the audit objective.

b. Choosing a sample size that is too small to achieve the sampling objective.
c. Failing to detect an error on a document that has been inspected by the auditor.
d. Failing to perform audit procedures that are required by the sampling plan.

Answer B

Choosing a sample size that is too small to achieve the sampling objective is an element of sampling risk

15. At times, a sample may indicate that the auditor's assessed level of control risk for a given control is
reasonable when, in fact, the true compliance rate does not justify the assessed level. This situation
illustrates the risk of

a. Assessing control risk too low.

b. Assessing control risk too high.
c. Incorrect precision.
d. Incorrect rejection.

Answer A

Assessing control risk too low indicates that the auditor's assessed level of control risk reasonable when
in fact not.
Difficult
1. According to the ethical standards of the profession, which of the following acts is generally
prohibited?

a. Purchasing a product from a third party and reselling it to a client.

b. Writing a financial management newsletter promoted and sold by a publishing company.
c. Accepting a commission for recommending a product to an audit client.
d. Accepting engagements obtained through the efforts of third parties.

Answer: C
The requirement is to determine which act is generally prohibited. Answer (c) is correct because
“a member in public practice shall not for a commission recommend or refer to a client any
product or service, or for a commission recommend or refer any product or service to be supplied
by a client, or receive a commission when the member or the member’s firm perform for that
client: (1) an audit of a financial statement; or (2) a compilation of a financial statement when the
member expects that a third party will use the financial statement and the member’s

2. On June 1, 20X8, a CPA obtained a $100,000 personal loan from a financial institution client for
whom the CPA provided compilation services. The loan was fully secured and considered
material to the CPA’s net worth. The CPA paid the loan in full on December 31, 20X9. On April 3,
20X9, the client asked the CPA to audit the client’s financial statements for the year ended
December 31, 20X9. Is the CPA considered independent with respect to the audit of the client’s
December 31, 20X9 financial statements?

a. Yes, because the loan was fully secured.

b. Yes, because the CPA was not required to be independent at the time the loan was
granted.
c. No, because the CPA had a loan with the client during the period of a professional
engagement.
d. No, because the CPA had a loan with the client during the period covered by the financial
statements.

Answer: B
Independence was not required at the time the loan was obtained, and because it is fully secured
it is grandfathered by 101-5. Answer (a) is incorrect because if the CPA is required to be
independent, a mortgage loan would not be permitted even if it was fully secured. Answer (c) is
incorrect because the CPA was not required to be independent of the client. Answer (d) is
incorrect because the CPA was not required to be independent of the client.

3. Which of the following is not true about international auditing standards?

a. International auditing standards do not require an audit of internal control.

b. International auditing standards do not allow reference to division of responsibilities in the
audit report.
c. International auditing standards require obtaining an attorney’s letter.
d. International auditing standards are based on a risk assessment approach.

Answer: C
The requirement is to identify the item that is not true about international auditing standards.
Answer (c) is correct because international auditing standards require obtaining an attorney’s
letter only if the auditors assess a risk of material misstatement. Answers (a), (b) and (d) are
incorrect because they are all true about international auditing standards.
4. Which of the following is most likely to be a response to the auditor’s assessment that the risk of
material misstatement due to fraud for the existence of inventory is high?

a. Observe test counts of inventory at certain locations on an unannounced basis.

b. Perform analytical procedures rather than taking test counts.
c. Request that inventories be counted prior to year-end.
d. Request that inventory counts at the various locations be counted on different dates so
as to allow the same auditor to be present at every count.

Answer: A
The requirement is to identify the most likely response to the auditor’s assessment that the risk of
material misstatement due to fraud for the existence of inventory is high. Answer (a) is correct
because observing test counts of inventory on an unannounced basis will provide evidence as to
whether record inventory exists. Answer (b) is incorrect because replacing test counts with
analytical procedures is not likely to be particularly effective. Answers (c) and (d) are incorrect
because the inventories might well be counted at year-end, all on the same date, rather than prior
to year-end and at differing dates.

5. Which of the following statements best describes the auditor’s responsibility to detect conditions
relating to financial stress of employees or adverse relationships between a company and its
employees?

a. The auditor is required to plan the audit to detect these conditions on all audits.
b. These conditions relate to fraudulent financial reporting, and an auditor is required to plan
the audit to detect these conditions when the client is exposed to a risk of
misappropriation of assets.
c. The auditor is required to plan the audit to detect these conditions whenever they may
result in misstatements.
d. The auditor is not required to plan the audit to discover these conditions, but should
consider them if he or she becomes aware of them during the audit.

Answer: D
The requirement is to identify an auditor’s responsibility for detecting financial stress of
employees or adverse relationships between a company and its employees. Answer (d) is correct
because AU-C 240 states that, while the auditor is not required to plan the audit to discover
information that is indicative of financial stress of employees or adverse relationships between the
company and its employees, such conditions must be considered when an auditor becomes
aware of them. Answers (a), (b), and (c) are all incorrect because the auditor does not plan the
audit to detect these conditions.

6. Chapel Company provided the following information in relation to the audit of its financial
statements:

2017 2016
Cash and cash equivalents 5,300,000 1,200,000
Accounts receivable 5,000,000 2,500,000
Inventory 2,000,000 1,500,000
Prepaid expenses 1,100,000 1,600,000
Investment in associate – 40% 22,000,000 19,000,000
Property, plant and equipment 17,000,000 22,500,000
Accumulated depreciation 5,000,000 6,000,000
Accounts payable 5,000,000 12,500,000
 Income tax payable 2,000,000 1,000,000
Deferred tax liability 3,000,000 2,000,000
Share capital 13,000.000 6,500,000
Retained earnings 24,500,000 20,000,000
● The net income for 2017 was P16,500,000.
● Equipment with carrying amount of P7,500,000 and original cost of 10,500,000 was sold for
P7,000,000 during 2017. New equipment was purchased for cash in 2017.
● The entity issued share capital and declared and paid cash dividends of P12,000,000 to
shareholders on December 31, 2017.
● The sales amounted to P30,000,000 and the cost of goods sold was P10,000,000 for the current
year.
● The associate reported net income of P10,000,000 and paid cash dividend of P2,500,000 during
2017.
What is the net cash provided by operating activities?

a. 11,000,000
b. 12,000,000
c. 9,000,000
d. 8,000,000

Answer: D

Net income 16,500,000

Loss on disposal 500,000
Share in net income (4,000,000)
Dividend received 1,000,000
Accounts receivable (2,500,000)
Inventory (500,000)
Prepaid expenses 500,000
Depreciation 2,000,000
Accounts payable (7,500,000)
Income tax payable 1,000,000
Deferred tax liability 1,000,000
Net cash provided by operating activities 8,000,000

7. Red Company reported net income of P7,410,000 for the current year. The auditor raised
questions about the following amounts that had been included in the net income:

Equity in earnings of Chester Company – 40% interest P1,700,000

Dividend received from Chester Company 300,000
Unrealized loss on available for sale investments (540,000)
Gain on early retirement of bonds payable 2,100,000
Adjustment of profit of prior year for error in depreciation, net of tax effect (750,000)
Loss from fire (1,500,000)
Gain from change in fair value attributable to credit risk of financial liability 500,000
at FVPL
What should be reported as adjusted net income?

a. 8,200,000
b. 9,500,000
c. 7,900,000
d. 8,400,000
 Answer: C

Unadjusted net income 7,410,000

Dividend received from Chester Company (300,000)
Unrealized loss on available for sale investments 540,000
Adjustment of profit of prior year for error in depreciation, net of tax effect 750,000
Gain from change in fair value attributable to credit risk of financial liability 500,000
at FVPL
Adjusted net income 7900,000

8. Blue, Inc. was organized on January 1, 2017. On December 31, 2018, the company lost most of
its inventory in a warehouse fire just before the yearend count of inventory was to take place. The
company’s records disclosed the following data:

2017 2018
Inventory, January 1 P 0 P204,000
Purchases 860,000 692,000
Purchase returns and allowances 46,120 64,600
Sales 788,000 836,000
Sales returns and allowances 16,000 20,000
On January 1, 2018, Blue’s pricing policy was changed so that the gross profit rate would be
three percentage points higher than the one earned in 2017. Salvaged undamaged merchandise
was marked to sell at P24,000 while damaged merchandise marked to sell at P16,000 had an
estimated realizable value of P3,600. How much is the inventory fire loss?

a. P189,000
b. P183,640
c. P164,920
d. P254,000

Answer: A

Inventory, January 1. 2018 P204,000

Add: Net Purchases (P692,000-64,600) 627,400
Goods available for sale 831,400
Less: Cost of goods sold:
Net Sales (836,000-20,000) P816,000
Cost ratio (100%-24%*) X76% 620,160
Estimated ending inventory 211,240
Less: Salvaged undamaged merchandise (P24,000x76%) P18,240
Net realizable value of damaged merchandise 3,600 21,840
Inventory fire loss P189,400
*The gross profit rate used for 2018 is computed by adding 3% to 21% gross profit rate for 2017
which is computed as follows:

Net Sales (P788,000-16,000) P772,000

Cost of goods sold:
Net purchases (P860,000-46,120) P813,880
Less: Inventory, December 31, 2017 204,000 609,880
Gross Profit, 2017 P162,120
Gross Profit rate, 2017 (P162,120/772,000) 21%

9. Ashley, Co. is authorized to issue 300,000 of P2 par value ordinary shares. The company has the
following transactions:
 ●Issued 60,000 shares at P30 per share; received cash.
●Issued 750 shares; selling at P35 per share, to lawyers for services in connection
with the organization of the corporation. The value of legal services was P27,000.
● Issued 900 shares, valued objectively at P30,000, to the employees instead of paying
them cash wages.
Issued 37,500 shares in exchange for a building valued at P885,000 and land valued
at P240,000. (The building was originally acquired by the investor for P750,000 and
has P300,000 of accumulated depreciation; the land was originally acquired for
P90,000)
● Received cash for 19,500 shares issued at P38 per share.
● Issued 12,000 shares at P45 per share; received cash.
The statement of financial position will report share premium of:

a. P4,000,950
b. P3,973,500
c. P4,001,700
d. P3,326,700

Answer: C

● P28 x 60,000 P1,680,000

● P27 – (2 x 750) 25,500
● P30,000 – (P2 x 900) 28200
● P885,000 + P240,000 = P1,125,000 – (P2 x 37,500) 1,050,000
● P36 x 19,500 702,000
● P43 x 12,000 516,000
Total share premium P4,001,700

10. Kim Company and its subsidiaries provided the following properties owned by the group.

Land held for undetermined future use P2,000,000

Vacant building to be leased out under an 3,000,000

operating lease

Property held for use in production 5,000,000

Property held by a subsidiary, a real estate 4,000,000

firm, in the ordinary course of business

Building owned by subsidiary and for which the 3,500,000

subsidiary provides security and maintenance
services to the lessees

Land leased to a subsidiary under an operating 2,500,000

lease

Equipment leased to an unrelated party under 1,000,000

an operating lease

Building under construction for use as 3,500,000

investment property
 In the consolidated statement of financial position of the parent and its subsidiaries, what total
amount should be reported as investment property?
a. 12,000,000
b. 10,000,000
c. 8,500,000
d. 6,500,000

Answer: A

Land held for undetermined future use P2,000,000

Vacant building to be leased out under an operating lease 3,000,000

Building owned by subsidiary and for which the subsidiary provides

security and maintenance services to the lessees 3,500,000

Building under construction for use as investment property 3,500,000

TOTAL P12,000,000

11. Jewel Corp. expended P510,000 in research and development costs. These activities resulted to
a new perfume called Touch. It was patented at additional legal and other costs of P54,000. The
patent application was filed on October 1, 2017, and the patent was estimated to have a useful
life of 10 years.

On June 1, 2019, Jewel spent P28,440 to successfully prosecute a patent infringement. In

addition, the patent’s estimated useful life was extended to 12 years from June 1, 2019. At the
beginning of 2021, Jewel determined that a competitor’s product would make the Secret Love
Song obsolete and the patent worthless by December 31, 2022. What is the amortization
expense for 2021?

a. P31,875
b. P19,531
c. P39,062
d. P3,750

Answer: B

Cost of Patent P54,000

Less: Amortization expense
2017 (P54,000/10 x 3/12) P1,350
2018 (P54,000/10) 5400
2019 Jan 1 – Jun 1 (P54,000/10 x 5/12) 2,250
Jun 1 – Dec 31 (P45,000/12 x 7/12) 2,188 4,438
2020 (P45, 000/12) 3,750 14,938
Unamortized cost, Jan 1, 2021 P39,062
Revised remaining life / 2yrs
Revised annual depreciation P19,531
 12. BLUE, Inc. estimates its bad debts losses by aging its accounts receivable. The aging schedule
of accounts receivable at December 31, 2017, is presented below:

Age of Accounts Amount

0 – 30 days P 843,200
31 – 60 days 461,000
61 – 90 days 192,400
91 – 120 days 76,650
Over 120 days 39,400
P1,612,650
BLUE’s uncollectible accounts experience for the past 5 years are summarized in the following
table.

Year AR Balance, 0 – 30 31 – 60 61 – 90 91 – 120 Over 120

Dec 31 days days days days days
2016 P1,312,500 0.3% 1.8% 12% 38% 65%
2015 999,999 0.5% 1.6% 11% 41% 70%
2014 465,000 0.2% 1.5% 9% 50% 69%
2013 816,000 0.4% 1.7% 10.2% 47% 81%
2012 1,243,667 0.9% 2.0% 9.7% 33% 95%
The balance of the allowance for bad debts account at December 31, 2017, (before adjustment)
is P84,500. The net realizable of the company’s account receivable on December 31, 2017
should be:
a. P1,518,887
b. P1,612,650
c. P1,528,150
d. P1,603,358

Answer: A

The average bad debts expense for each category is computed first, as follows:

Year 0 – 30 31 – 60 61 – 90 91 – 120 Over 120

days days days days days
2016 0.3% 1.8% 12% 38% 65%
2015 0.5% 1.6% 11% 41% 70%
2014 0.2% 1.5% 9% 50% 69%
2013 0.4% 1.7% 10.2% 47% 81%
2012 0.9% 2.0% 9.7% 33% 95%
Total 2.30% 8.60% 51.90% 209% 380%
Average 0.46% 1.72% 10.38% 41.80% 76.00%

Then, the computation of required allowance for bad debts:

Age of Accounts AR Balance, Rate Estimated

12/31/17 Uncollectible
0 – 30 days P 843,200 0.46% P3,878.72
31 – 60 days 461,000 1.72% 7,929.20
61 – 90 days 192,400 10.38% 19,971.12
91 – 120 days 76,650 41.80% 32,039.70
Over 120 days 39,400 76% 29,944.00
P1,612,650 P93,762.74

Accounts receivable P1,612,650

Less: Required allowance balance per aging 93,763
Net realizable value, December 31, 2017 P1,518,887

13. You were able to obtain the following from the accountant for Isabella Corp. related to the
company’s liabilities as of December 31, 2017.

Accounts payable P 650,000

Notes payable – trade 190,000
Notes payable – bank 800,000
Wages and salaries payable 15,000
Interest payable ?
Mortgage notes payable – 10% 600,000
Mortgage notes payable – 12% 1,500,000
Bonds payable 2,000,000
The following additional information pertains to these liabilities.

o All trade notes payable are due within six months of the balance sheet date.
o Bank notes-payable include two separate notes payable to Allied Bank.
▪ A P300,000, 8% note issued March 1, 2015, payable on demand. Interest is
payable every six months.
▪ A 1-year, P500,000, 11 ½% note issued January 2, 2017. On December 30,
2017, Isabella negotiated a written agreement with Allied Bank to replace the
note with a 2-year, P500,000, 10% note to be issued January 2, 2018. The
interest was paid on December 31, 2017.
o The 10% mortgage note was issued October 1, 2014, with a term of 10 years. Terms of
the note give the holder the right to demand immediate payment if the company fails to
make a monthly interest payment within 10 days of the date the payment is due. As of
December 31, 2017, Isabella is three months behind in paying its required interest
payment.
o The 12% mortgage note was issued May 1, 2011, with a term of 20 years. The current
principal amount due is P1,500,000. Principal and interest payable annually on April 30.
A payment of P220,000 is due April 30, 2018. The payment includes interest of
P180,000.
o The bonds payable is 10-year, 8% bonds, issued June 30, 2008. Interest is payable
semi-annually every June 30 and December 31.

Based on the above and the result of your audit, Interest payable as of December 31, 2017 is

a. P155,000
b. P143,000
c. P203,000
d. P215,000

Answer: B

P300,000 note payable to bank (P300,000 x 8% x 4/12) P8,000

Mortgage note payable – 10% (P600,000 x 10% x 3/12) 15,000
Mortgage note payable – 12% (P1,500,000 x 12% x 8/12) 120,000
Total interest payable, 12/31/17 P143,000
14. When an auditor is unable to inspect and count a client’s investment securities until after the
balance sheet date, the bank where the securities are held in a safe-deposit box should be asked
to
 a. Verify any differences between the contents of the box and the balances in the client’s
subsidiary ledger.
b. Provide a list of securities added and removed from the box between the balance sheet
date and the security-count date.
c. Confirm that there has been no access to the box between the balance sheet date and
the security-count date.
d. Count the securities in the box so the auditor will have an independent direct verification.

Answer: C

Banks maintain the access to safe-deposit boxes. Thus, the confirmation of no access during the
period will provide the auditor with evidence that the securities in the safe-deposit box at the time
of count were those available at year-end.

15. A group engagement partner decides not to refer to the audit of another CPA who audited a
component of the overall group financial statements. After making inquiries about the other CPA’s
professional reputation and independence, the principal auditor most likely would

a. Add an emphasis-of-matter paragraph to the auditor’s report indicating that the

subsidiary’s financial statements are not material to the consolidated financial statements.
b. Document in the engagement letter that the principal auditor assumes no responsibility
for the other CPA’s work and opinion.
c. Obtain written permission from the other CPA to omit the reference in the principal
auditor’s report.
d. Perform additional audit procedures based on the significance of the subsidiary.

Answer: D
When a decision is made not to make reference to the component auditor—that is, to take
responsibility for that auditor’s work—the group auditor should perform additional procedures
dependent upon the significance of the component.

Auditing
Easy

1. Arrangements concerning which of the following are leastlikely to be included in engagement

letter?
a. A predecessor auditor.
b. Fees and billing.
c. CPA investment in client securities.
d. Other services to be provided in addition to the audit.

Answer: C

PSA does not suggest anyarrangement concerning CPA investment in client securities;indeed such
investments are prohibited by Code of Ethics.

2. Analytical procedures used during risk assessment in anaudit should focus on

a. Reducing the scope of tests of controls and substantivetests.
b. Providing assurance that potential material misstatementswill be identified.
c. Enhancing the auditor’s understanding of the client’sbusiness.
d. Assessing the adequacy of the available evidence.
Answer: C

Analytical procedures used duringrisk assessment may enhance the auditor’s understanding of theclient’s
business and significant transactions and events that haveoccurred since the prior audit and also may
help to identify theexistence of unusual transactions or events and amounts, ratios,and trends that might
indicate matters that have audit implications.

3. Which of the following is not a component of an entity’sinternal control?

a. Control risk.
b. Control activities.
c. Monitoring.
d. Control environment.

Answer: A

While auditors assess control risk as a part of their considerationof internal control, it is not a component
of an entity’sinternal control.

4. An auditor may compensate for a weakness in internal controlby increasing the

a. Level of detection risk.
b. Extent of tests of controls.
c. Preliminary judgment about audit risk.
d. Extent of analytical procedures.

Answer: D

Increasing analytical procedures decreasesdetection risk in a manner which may counterbalance the
conditionin internal control. In effect, the weakness in internal controlis compensated for by increased
substantive testing.

5. Which of the following departments most likely would approve changes in pay rates and
deductions from employeesalaries?
a. Personnel.
b. Treasurer.
c. Controller.
d. Payroll.

Answer: A

The personneldepartment, which has the primary objective of planning, controllingand coordinating
employees, will determine that proposedsalary increases (often recommended by supervisors
ofemployees) are consistent with the company’s salary guidelinesand will approve changes in deductions.

6. Which of the following is not an assertion relating to classesof transactions?

a. Accuracy.
b. Consistency.
c. Cutoff.
d. Occurrence.

Answer: B

The assertions for classes of transactions are occurrence, completeness, accuracy, cutoffand
classification.

7. The permanent file of an auditor’s working papers generally would not include
a. Bond indenture agreements.
b. Lease agreements.
 c. Working trial balance.
d. Flowchart of internal control.

Answer: C

Permanent files include informationaffecting a number of years’ audits, and the workingtrial balance
relates most directly to the current and, to a limitedextent, the subsequent year’s audit.

8. An auditor most likely would analyze inventory turnover rates to obtain evidence concerning
management’s assertionsabout
a. Existence.
b. Rights.
c. Presentation.
d. Valuation.

Answer: D

An analysis of inventoryturnover rates will provide the auditor with evidence on slowmoving,excess,
defective, and obsolete items included in inventories.These items may be improperly valued.

9. A summary of findings rather than assurance is most likelyto be included in

a. Agreed-upon procedures report.
b. Compilation report.
c. Examination report.
d. Review report.

Answer: A

Agreed-upon proceduresreports include a summary of findings.

10. An accountant’s compilation report should be dated as ofthe date of

a. Completion of fieldwork.
b. Completion of the compilation.
c. Transmittal of the compilation report.
d. The latest subsequent event referred to in the notes tothe financial statements.

Answer: B

PSRS require that thedate of completion of the compilation should be used.

11. A number of factors influences the sample size for a substantive test of details of an account
balance. All other factors being equal, which of the following would lead to a larger sample size?
a. Greater reliance on internal control.
b. Greater reliance on analytical procedures.
c. Smaller expected frequency of errors.
d. Smaller measure of tolerable misstatement.

Answer: D

The sample size required to achievethe auditor’s objective at a given risk of incorrect
acceptanceincreases as the auditor’s assessment of tolerable misstatementfor the balance or class
decreases.

12. Which of the following methods of testing application controls utilizes a generalized audit software
package prepared by theauditors?
a. Parallel simulation.
b. Integrated testing facility approach.
 c. Test data approach.
d. Exception report tests.

Answer: A

The parallel simulation method processes theclient’s data using the CPA’s software.

13. Which of the following controls most likely would reducethe risk of diversion of customer receipts
by an entity’s employees?
a. A bank lockbox system.
b. Prenumbered remittance advices.
c. Monthly bank reconciliations.
d. Daily deposit of cash receipts.

Answer: A

A bank lockboxsystem eliminates employee contact with cash receipts, andthereby greatly reduces the
risk of diversion by employees.

14. According to the Code of Ethics for Professional Accountants in the Philippines, close family
include the following, except
a. Parent
b. Non-dependent child
c. Sibling
d. Spouse

Answer: D

Spouse is considered as an immediate family member by the Code of Ethics for Professional Accountants
in the Philippines.

15. Which of the following is the least required in attaining professional competence?
a. High standard of general education.
b. Specific education, training and examination in professionally relevant subjects.
c. Period of meaningful work experience.
d. Continuing awareness of development in the accountancy profession.

Asnwer: D

Continuing awareness of development in the accountancy profession is required for maintaining

professional competence.

Average

1. An auditor believes that an understanding with the client has not been established. In this case,
the auditor should ordinarily:
a. Perform the engagement with renewed professional skepticism.
b. Decline to accept or perform the engagement.
c. Assess control risk at a high level and rely primarily on substantive audit procedures.
d. Modify the assessment of risk due to fraud.

Answer: B
PSA 210 requires that an understanding with the client should be established. Accordingly, if such
an understanding is not reached, the auditor should decline to accept or perform the
engagement.
2. Audit program may be either predetermined or progressive. All of the following are advantages of
a predetermined audit program, except that
a. It places responsibility for each audit procedure.
b. It encourages independent, constructive thinking.
c. It results in proper audit routine and saves time.
d. It assures adherence to auditing standards and the application of GAAP.

Answer: B
Pre-determined audit programs are template programs (standard procedures) which are usually
tailored to suit an engagement. Progressive audit programs are developed as the audit
progresses. Pre-determined audit programs discourage independent, constructive thinking,
because the staff will have a tendency of just completing standard programs without considering
if additional or modified procedures would better suit an engagement.

3. Which of the following best describes due care?

a. Tact in avoiding legal liability
b. Requisite skill and diligence
c. Reasonable infallibility
d. Freedom from undue influence

Answer: B
Due care requires auditor to conscientiously preform every aspect of the audit. It requires the
application of skill and diligence in performing an engagement.

4. Maria Cristina, CPA, has an audit client, Claveria Inc., which uses another CPA for management
services work. Maria Cristina sends her firm’s literature covering its management services
capabilities to Valencia, Inc. on an unsolicited monthly basis. In addition, Maria Cristina has
provided a list of criticisms of the work of the other CPA.
a. Maria Cristina is violating the code of professional ethics because this is a form of
advertising.
b. Maria Cristina is violating the rules on promotion of work by professional accountants.
c. Maria Cristina is violating the code of professional ethics unless she obtains the other
CPA’s permission to mail such literature to Valencia, Inc.
d. Maria Cristina is not violating the code of professional ethics.

Answer: B
Maria Cristina is violating the rules on promotion of work by CPAs, which states that CPAs should
not denigrate the work of other accountants.

5. This refers to the gathering of professionals which shall include among others, workshops,
technical lectures or subject matter meetings, non-degree training courses and scientific
meetings.
a. Seminars
b. Conventions
c. Meetings
d. Professional gathering

Answer: A
Annex C of the IRR to RA9298, Section 3(b) provides the following definitions:
 Seminars shall refer to the gathering of professionals which shall include among others,
workshops, technical lectures or subject matter meetings, non-degree training courses and
scientific meetings.

6. Which of the following is not an information source for developing analytical procedures used in
the audit?
a. Relationships among financial statement elements.
b. Relationships between financial and relevant non-financial data.
c. Comparison of financial data with anticipated results (such as budgets or forecasts).
d. Comparison of current year financial data with projections for next year’s financial results.

Answer: D
Current year financial data may be compared against expectations developed from:
● Prior-year financial data
● Budget data for the same year
● Industry averages

7. Which of the following is included in the seal used by a Certified Public Accountant?
a. Professional tax receipt (PTR) number
b. Community Tax Certificate number
c. Tax identification Number (TIN)
d. CPA Registration number

Answer: D
Choices A to C are indicated by the auditor in audit reports issued in connection with an
engagement (SEC Circular). Choice D is indicated in the lower portion of the CPA seal (refer to
Section 33 of the Implementing Rules and Regulations to RA9298).

8. The auditor’s duty of confidentiality would ordinarily preclude the reporting of fraud or error to a
third party. However, in certain circumstances, the duty of confidentiality is justifiably overridden
by the following, except:
a. Law
b. Statute
c. Courts of law
d. Pressure from a competitor of the audit client.

Answer: D
In summary, rule on confidentiality may be overridden, by the following:
● Where specific authority has been obtained from the client.
● Where disclosure is required by law.
● Where there is a professional right or duty to disclose.

For Nos. 9 to 11.

At the beginning of year 1, an entity grants to a senior executive 30,000 share options. The grant is
conditional upon the executive remaining in the entity’s employ until the end of year 3.

The share options can be exercised if the entity’s share price increases from P20 at the beginning of year
1 to above P30 at the end of year 3. If the share price is above P30 at the end of year 3, the share
options can be exercised at any time during the next five years, i.e., by the end of year 8.
The entity estimates the fair value of the share options on grant date to be P5 per option. This estimate
takes into account the following market condition:
The possibility that the share price will exceed P30 at the end of year 3, i.e., the share options become
exercisable; and
The possibility that the share price will not exceed P30 at the end of year 3, i.e., the share options will be
forfeited.

The following actual events occurred in years 1 to 3:

Year 1

The share price has increased to P24.

The entity’s estimate of the fair value of the options is P4 at the end of year 1. This takes into account
whether the market condition will be satisfied by the end of year 3.

Year 2

The share price has decreased to P22. However, the entity remains optimistic that the share price target
will be met by the end of year 3.
The estimated fair value of the share options is P3. Again, this estimate takes into account the market
condition noted above.

Year 3

The share price only reaches P28 by the end of year 3.

The estimated fair value of the share options is zero, as the market condition has not been satisfied.

Based on the preceding information, determine the following:

9. Compensation expense for year 1

a. Php30,000
b. Php40,000
c. Php50,000
d. Php50,000

10. Compensation expense for year 2

a. Php30,000
b. Php40,000
c. Php50,000
d. Php60,000

11. Compensation expense for year 3

a. Php0
b. Php30,000
c. Php40,000
d. Php50,000

Answers for 9 to 11
9. C
10. C
11. D

Compensation Cumulative
 Expense Compensation
Year Calculation for Period Expense
1 30,000 options x P5 fair value x 1⁄3 P50,000 P50,000
2 30,000 options x P5 fair value x 1⁄3 50,000 100,000
3 30,000 options x P5 fair value x 1⁄3 50,000 150,000

For Nos. 12 to 15

A portion of the SPARK COMPANY’s statement of financial position appears as follows:

December 31, 2017 December 31, 2016
Assets:
Cash P353,300 P100,000
Notes receivable 0 25,000
Inventory ? 199,875
Liabilities:
Accounts payable ? 75,000

Spark Company pays for all operating expenses with cash and purchases all inventory on credit. During
2017, cash totaling P471,700 was paid on accounts payable. Operating expenses for 2017 totaled
P220,000. All sales are cash sales. The inventory was restocked by purchasing 1,500 units per month
and valued by using periodic FIFO. The unit cost of inventory was P32.60 during January 2017 and
increased P0.10 per month during the year. Spark sells only one product. All sales are made for P50 per
unit. The ending inventory for 2016 was valued at P32.50 per unit.

Based on the preceding information, compute the following:

12. Number of units sold during 2017

a. 7,066
b. 18,400
c. 4,268
d. 13,400

13. Accounts payable balance at December 31, 2017

a. P190,100
b. P50,000
c. P199,100
d. P200,000

14. Inventory quantity on December 31, 2017

a. 5,750
b. 2,750
c. 17,084
d. 10,750

15. Cost of inventory on December 31, 2017

a. P187,450
b. P186,875
c. P192,250
d. P189,660

Answers for 12 to 15:

 12. B

Cash balance, Dec. 31, 2016 P100,000

Sales (SQUEEZE) 920,000
Cash paid for operating expenses (220,000)
Cash paid on accounts payable (471,700)
Collections on notes receivable __25,000
Cash balance, Dec. 31, 2017 P353,300

Units sold (P920,000/P50) 18,400

13. D

Accounts payable:
Balance, Dec. 31, 2016 P75,000
Purchases 596,700*
Cash payments on accounts payable (471,700)
Balance, Dec. 31, 2017 P200,000

*Purchases:
Month Unit Cost Units Total Cost
January P32.60 1,500 P48,900
February 32.70 1,500 49,050
March 32.80 1,500 49,200
April 32.90 1,500 49,350
May 33.00 1,500 49,500
June 33.10 1,500 49,650
July 33.20 1,500 49,800
August 33.30 1,500 49,950
September 33.40 1,500 50,100
October 33.50 1,500 50,250
November 33.60 1,500 50,400
December 33.70 1,500 __50,550
Total purchases 18,000 P596,700

Or (P32.60 + P33,70)/2 x (1,500 x 12) = P596,700

14. A

Inventory, Dec. 31, 2016 (P199,875/P32.50) 6,150

Purchases 18,000
Units sold (18,400)
Inventory, Dec. 31, 2017 5,750

15. C

FIFO cost of inventory, Dec. 31, 2017:

December purchases 1,500 x P33.70 P 50,550
November purchase 1,500 x P33.60 50,400
October purchase 1,500 x P33.50 50,250
September purchase 1,250 x P33.40 __41,750
5,750 P192,950

Difficult
1. On June 30, 2017, the HOPE COPPER MINES, INC. purchased a copper mine for P14,580,000.
The estimated capacity of the mine was 1,620,000 tons. HOPE Copper Mines expects to extract
15,000 tons of ore a month with an estimated selling price of P50 per ton. Production started
immediately after some new machines costing P1,800,000 were bought on June 30, 2017. These
new machines had an estimated useful life of 15 years with a scrap value of 10% of cost after the ore
estimate has been extracted from the property, at which time the machines will already be useless.
HOPE’s books show the following expenses for 2015:

Depletion expense P1,215,000

Depreciation—Machinery 120,000

Recorded depletion expense was

A. Overstated by P270,000.

B. Understated by P270,000.

C. Overstated by P405,000

D. Understated by P405,000.

Answer: C

Depletion rate per ton (P14,580,000 / 1,620,000) P9

Copper ore mined in 2015 (15,000 x 6 months) x 90,000

Depletion for 2017 P 810,000

Depletion per books 1,215,000

Overstatement of depletion expense P405,000

2. FAITH COMPANY purchased a machine for P300,000 on January 1, 2014, with the following
additional items paid or incurred:

Separation pay for laborer laid off upon acquisition of new machine P3,600

Loss on sale of machine replaced 3,900

Transportation in 3,000

Installation cost 12,000

The new machine is estimated to have a useful life of 10 years and a residual value of P12,000.

On January 1, 2017, new parts which cost P37,800 were added to the machine so as to reduce its fuel
consumption, but with no change in its estimated life or residual value.
The annual depreciation charge on the machine for 2017 was

A. P34,080 B. P35,494 C. P36,450 D. P35,700

Answer: D

January 1, 2014

Total cost of machine (P300,000 + P3,000 + P12,000) P315,000

Residual value (12,000)

Depreciable cost P303,000

Estimated useful life

10 years

Annual depreciation P30,300

Depreciable cost P303,000

Depreciation, 2014 – 2017 (P30,300 x 3 years) (90,000)

Remaining depreciable cost, Jan. 1, 2015 P212,100

Cost of new parts 37,800

Total P249,900

Remaining useful life (10 years – 3 years)

7 years

Revised annual depreciation P35,700

3. LOVE COMPANY buys and sells securities expecting to earn profits on short-term differences in
price. During 2017, Love Company purchased the following trading securities:
Fair Value

Security Cost Dec. 31, 2017

A P 585,000 P 675,000

B 900,000 486,000

C 1,980,000 2,034,000

Before any adjustments related to these trading securities, Love Company had net income of
P2,700,000.

What is Love’s net income after making any necessary trading security adjustments?

A. P2,430,000 B. P2,286,000 C. P2,934,000 D. P2,700,000

Answer: A

Net income before trading security adjustment P2,700,000

Unrealized loss (P3,465,000 cost – P3,195,000 market value) (270,000)

Net income, as adjusted P2,430,000

4. KINDNESS CO.’s portfolio of trading securities includes the following on December 31, 2016:

Cost Fair Value

15,000 ordinary shares of Jacob Co.P1,431,000 P1,251,000

30,000 ordinary shares of Esau Co. 1,638,000 1,710,000

P3,069,000 P2,961,000

All of the above securities have been purchased in 2016. In 2017, KINDNESS Co. completed the
following securities transactions:

Mar. 1 Sold 15,000 shares of Jacob Co. ordinary shares at P93, less brokerage commission of
P13,500.

April 1 Bought 1,800 ordinary shares of Israel, Inc. at P135 plus commission, taxes, and other
transaction costs of P4,950.

The KINDNESS Co. portfolio of trading securities appeared as follows on December 31, 2017:

Cost Fair Value

30,000 ordinary shares of Esau Co.

P1,638,000
P1,740,000 1

1,800 ordinary shares of Israel, Inc. 247,950 225,0002

P1,885,950
P1,965,000
1
Net of P19,500 estimated transaction costs that would be incurred on the sale of the securities.
2
Net of P4,500 estimated transaction costs that would be incurred on the sale of the securities.

What is the gain on the sale of Jacob Co. ordinary shares on March 1, 2017?

A. P144,000 B. P27,000 C. P130,500 D. P13,500

Answer: C

Net proceeds (P93 x 15,000 = P1,395,000 – P13,500) P1,381,500

Carrying value (1,251,000)

Gain on sale P 130,500

5. On January 1, 2016, PATIENCE MFG. CO. began construction of a building to be used as its office
headquarters. The building was completed on June 30, 2017.

Expenditures on the project were as follows:

January 3, 2016 P2,500,000

March 31, 2016 3,000,000

June 30, 2016 4,000,000

October 31, 2016 3,000,000

January 31, 2017 1,500,000

March 31, 2017 2,500,000

May 31, 2017 3,000,000

On January 3, 2016, the company obtained a P5 million construction loan with a 10% interest rate. The
loan was outstanding all of 2016 and 2017. The company’s other interest-bearing debts included a
long-term note of P25 million with an 8% interest rate, and a mortgage of P15 million on another building
with an interest rate of 6%. Both debts were outstanding during all of 2016 and 2017. The company’s
fiscal year-end is December 31.

What amount of interest should be expensed in 2016?

A. P2,736,875 B. P2,356,250
C. P2,900,000 D. P0

Answer: A

Actual borrowing cost:

Specific borrowing (P5 million x 10%) P500,000

General borrowings:

P25 million x 8% P2,000,000

P15 million x 6% 900,000 2,900,000

 Total P3,400,000

Capitalization rate (P2,900,000/P40 million)

7.25%

Average expenditures – 2014 P7,250,000

Capitalizable interest – 2014:

Specific borrowing (P5 million x 10%) P500,000

General borrowings (P7,250,000 – P5,000,000 = P2,250,000 x 7.25%)

163,125

Total P663,125

2016 interest expense (P3,400,000 – P663,125) P2,736,875

6. The December 31 year-end financial statements of PERSEVERANCE COMPANY contained the

following errors:
Dec. 31, 2016 Dec. 31, 2017

Ending inventory P48,000 understated P40,500 overstated

Depreciation expense P11,500 understated -------

An insurance premium of P330,000 was prepaid in 2016 covering the years 2016, 2017, and 2018. The
entire amount was charged to expense in 2016. In addition, on December 31, 2017, a fully depreciated
machinery was sold for P75,000 cash, but the sale was not recorded until 2018. There were no other
errors during 2016 and 2017, and no corrections have been made for any of the errors. Ignore income
tax effects.

What is the total effect of the errors on the amount of Perseverance’s working capital at December 31,
2017?

A. P75,500 overstatement

B. P40,500 overstatement

C. P225,500 understatement

D. P144,500 understatement

Answer: D

Over- (Under-)statement

Overstatement of 2015 ending inventory P 40,500

Prepaid insurance charged to expense in 2014(110,000)

 Unrecorded sale of fully depreciated machinery in 2015 (75,000)

Total effect on working capital (P144,500)

7. GENTLE, INC., a dealer of household appliances, sells washing machines at an average price of
P8,100. The company also offers to each customer a separate 3-year warranty contract for P810 that
requires the company to provide periodic maintenance services and to replace defective parts.
During 2016, GENTLE sold 300 washing machines and 270 warranty contracts for cash. The
company estimates that the warranty costs are P180 for parts and P360 for labor.

Assume sales occurred on December 31, 2016. GENTLE’s policy is to recognize income from the
warranties on a straight-line basis. In 2017, GENTLE incurred actual costs relative to 2016 warranty
sales of P18,000 for parts and P36,000 for labor.

What liability relative to these transactions would appear on the December 31, 2016, statement of
financial position and how would it be classified?

Current Noncurrent

A. P145,800 P72,900

B. P72,900 P72,900

C. P72,900 P145,800

D. P0 P218,700

Answer: C

Unearned warranty revenue:

Current (P810 x 270 x 1/3) P72,900

Non-current (P810 x 270 x 2/3) P145,800

8. To substantiate the existence of the accounts receivable balances as at December 31, 2017 of
CANAAN COMPANY, you have decided to send confirmation requests to customers. Below is a
summary of the confirmation replies together with the exceptions and audit findings. Gross profit on
sales is 20%. The company is under the perpetual inventory method.

Name of Balance Comments

Customer Per From Customers Audit Findings
Books
Concordia P150,000 P90,000 was returned on December Returned goods were
30, 2015. Correct balance as is received December 31,
P60,000. 2017.
Falcon P30,000 Your CM representing price adjustment The CM was taken up by
dated December 28, 2015 cancels this. Canaan Company in 2018.
Lazaro P144,000 You have overpriced us by P150. The complaint is valid.
Correct price should be P300.
Silang P112,500 We received the goods only on January Term is shipping point.
6, 2018. Shipped in 2017.
Yakal P135,000 Balance was offset by our December Canaan Company credited
shipment of your raw materials. accounts payable for
P135,000 to record
purchases. Yakal is a
supplier.

The accounts receivable from Silang is

A. Correctly stated. C. P112,500 under.

B. P112,500 over. D. P225,000 under.

Answer: A

Correctly stated because the goods are considered sold in 2017.

9. A portion of the PROMISE LAND COMPANY’s statement of financial position appears as follows:

December 31, 2017 December 31, 2016

Assets:

Cash P353,300 P100,000

Notes receivable 0 25,000

Inventory ? 199,875

Liabilities:

Accounts payable ? 75,000

Promise land Company pays for all operating expenses with cash and purchases all inventory on credit.
During 2017, cash totaling P471,700 was paid on accounts payable. Operating expenses for 2017
totaled P220,000. All sales are cash sales. The inventory was restocked by purchasing 1,500 units per
month and valued by using periodic FIFO. The unit cost of inventory was P32.60 during January 2017
and increased P0.10 per month during the year. Promise land sells only one product. All sales are made
for P50 per unit. The ending inventory for 2016 was valued at P32.50 per unit.

Based on the preceding information, compute the following:

Number of units sold during 2017

 A. 7,066 B. 18,400 C. 4,268 D. 13,400

Answer: B

Cash balance, Dec. 31, 2016 P100,000

Sales (SQUEEZE) 920,000

Cash paid for operating expenses (220,000)

Cash paid on accounts payable (471,700)

Collections on notes receivable 25,000

Cash balance, Dec. 31, 2017 P353,300

Units sold (P920,000/P50) 18,400

10. A note receivable amounting to P1,300,000 represents a loan granted to a subsidiary. This is
covered by a promissory note with interest at 15% per annum dated November 1, 2017. No interest
has been accrued on the note as of December 31, 2017. What is the adjusted balance of Notes and
interest receivable?

Notes and interest receivable

A. P1,331,960 B. P1,332,160 C. P1,332,500 D. P1,300,000

Answer: C

Notes and interest receivable

Per books P1,300,000

*AJE 32,500

Per audit P1,332,500

*AJE

Interest receivable 32,500

Other income (Interest income) 32,500

(P1,300,000 x 15% 2/12)

11. Which of the following types of audit evidence is the most persuasive?
a. Prenumbered client purchase order forms.
 b. Client work sheets supporting cost allocations.

c. Bank statements obtained from the client.

d. Client representation letter.

Answer: C

The requirement is to identify the most persuasive type of evidence. Answer (c) is correct because a
bank statement represents evidence prepared outside of the entity and is considered an audit
evidence source which provides the auditor with a high level of assurance. Answers (a), (b), and (d)
are incorrect because prenumbered client purchase order forms, client work sheets and a
representation letter all represent internally generated documents, generally considered less
persuasive than externally generated documents. See IAS 106 for information on the
persuasiveness of audit evidence.

12. In evaluating an entity’s accounting estimates, one of an auditor’s objectives is to determine whether
the estimates are
a. Not subject to bias.

b. Consistent with industry guidelines.

c. Based on objective assumptions.

d. Reasonable in the circumstances.

Answer: D

The requirement is to identify one of an auditor’s objectives when evaluating an entity’s accounting
estimates. Answer (d) is correct because when evaluating accounting estimates an auditor’s
objectives are to obtain sufficient appropriate audit evidence that (1) all material accounting
estimates have been developed, (2) those accounting estimates are reasonable, and (3) those
accounting estimates are in conformity with GAAP.

13. What type of analytical procedure would an auditor most likely use in developing relationships among
balance sheet accounts when reviewing the financial statements of a nonpublic entity?
a. Trend analysis.

b. Regression analysis.

c. Ratio analysis.

d. Risk analysis.

Answer: C

The requirement is to identify the type of analytical procedure an auditor would most likely use in
developing relationships among balance sheet accounts when reviewing the financial statements of a
 nonpublic entity. Answer (c) is correct because balance sheet accounts may be analyzed through a
number of ratios (e.g., current ratio). Answer (a) is incorrect because trend analysis is often more
appropriate for income statement analysis. Answer (b) is incorrect because regression analysis, while
used in practice, is not used as frequently as is ratio analysis. Answer (d) is incorrect because risk
analysis in and of itself is not a type of analytical procedure.

14. The objective of tests of details of transactions performed as substantive tests is to

a. Comply with generally accepted auditing standards.

b. Attain assurance about the reliability of the accounting system.

c. Detect material misstatements in the financial statements.

d. Evaluate whether management’s policies and procedures operated effectively.

Answer: C

The requirement is to identify the objective of tests of details of transactions performed as substantive
tests. Answer (c) is correct because IAS 110 states that the objective of tests of details of transactions
performed as substantive tests is to detect material misstatements in the financial statements.
Answer (a) is incorrect because while performing tests of details of transactions as substantive tests
complies with generally accepted auditing standards, this is not their objective. Answers (b) and (d)
are incorrect because neither attaining assurance about the reliability of the accounting system nor
the evaluation of the operating effectiveness of management’s policies and

Procedures are the objective of tests of details of transactions performed as substantive tests.

15. Ignoring any particular legal or regulatory requirement, audit documentation should be retained
a. A minimum of five years.

b. As long as lead schedules have relevance to forthcoming audits.

c. Until 3 years after the client selects another auditor.

d. Working papers must be maintained indefinitely.

Answer: A

The requirement is to determine how long audit documentation must be retained. Answer (a) is
correct because IAS 103 requires that they be maintained a minimum of five years. Answers (b), (c),
and (d) all present other, incorrect time periods.