UNIT 1

AUDIT OF INVESTMENT PROPERTY, NON CURRENT ASSETS HELD FOR SALE

AND DISCONTINUED OPERATIONS
Estimated Time: 2.5 HOURS
*Use Louwers 4th edition

Discussion Questions 1- 1: Nature of Investment Property

1. Define investment property and owner-occupied property.

2. What are the initial recognition criteria for investment property? How should it be
measured initially and subsequently?
3. Considering the nature, initial recognition and subsequent measurement of
investment property, what are the usual assertions tested with regard investment
property?
4. Referring to question #3, enumerate possible risks for each assertion.

Discussion Question 1-2: Substantive Procedures over Investment Property*

Refer to Louwers Question 8.47 page 338.

*Property, plant and equipment terms are assumed to be investment property

Problem 1-1: Investment Property and Owner Occupied Property

Identify the proper classification of the following items:
1. land held for long-term capital appreciation rather than for short-term sale in the
ordinary course of business.
2. land held for a currently undetermined future use. (If an entity has not determined
that it will use the land as owner-occupied property or for short-term sale in the
ordinary course of business, the land is regarded as held for capital appreciation.)
3. a building owned by the entity (or held by the entity under a finance lease) and
leased out under one or more operating leases.
4. a building that is vacant but is held to be leased out under one or more operating
leases.
5. property that is being constructed or developed for future use as investment
property.
6. property intended for sale in the ordinary course of business or in the process of
construction or development for such sale
7. property being constructed or developed on behalf of third parties
8. property held for future use as owner-occupied property
9. property held for future development and subsequent use as owner-occupied
property,
10. property held for future development and subsequent use to be occupied by
employees
11. property that is leased to another entity under a finance lease.

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-1
Problem 1-2: Investment Property

ABC Co. has the following assets:

Particulars Amount
Land held for long-term capital appreciation 200,000
Land held for a currently undetermined future use 700,000
Land held for future plant site 1,000,000
Land held for sale in ordinary course of business 100,000
Building rented out under finance lease 1,900,000
Building rented out under operating lease 800,000
Building held under an operating lease 1,100,000
Building held under finance lease and rented out under
operating lease 1,200,000
Equipment leased out under an operating lease 50,000

Requirement: Determine the total investment property.

Problem 1-3: Investment Property and Owner Occupied Property

DEF Co. has the following assets:

Particulars Amount
Vacant building to be leased out under operating lease 1,000,000
Building being constructed for XYZ, Inc. 200,000
Building under construction to be used as office 400,000
Building under construction to be rented out under operating
lease 100,000
Building rented out to DEF’s employees who pay rent at market
rates 800,000
Office building awaiting disposal 50,000

Requirement: Determine the total investment property.

Problem 1-4: Property that is partly investment property and partly-owner occupied
A. Portions sold separately
GHI Co. has a 10-storey condominium building with a carrying amount of P4,000,000.
The first 4 floors are being rented out to tenants under operating lease and the rest are
used as office space. Each portion of the building can be sold separately or leased out
separately under finance lease.

Assuming that the fair values of the condominium units are approximately equal, how
much is classified as investment property and how much is classified as owner-occupied
property?

B. Portions not sold separately

JKL Co. owns a 100,000 square meter mall. The rentable space is 80,000 square
meters. However, a 10 square meter space is occupied as an administration office. The
carrying amount of the building is P10,000,000.

Requirement: How much is classified as investment property and how much is classified
as owner-occupied property?

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-2
Problem 1-5: Investment Property and Owner Occupied Property
AY Company, wholly-owned corporation of BSP Company, is engaged in various
businesses namely real estate development, leasing, and food court operations. The
valuation of investment property in AY Company’s December 31, 2014 statement of
financial position amounted to P21,504,300. Supporting schedule of the Company
presents the following composition:

Particulars Amount
A large open space is leased by AY Company under operating P 4,600,000
lease and is leased out to third parties under operating lease
A building held under a finance lease that is used for food court 3,800,000
operations. The building is divided into different food stalls with
kitchen space and is leased out to various entrepreneurs
Building held primarily for sale 3,000,000
Property being constructed for future use as investment property 2,700,000
A piece of land owned whose title is leased to a third party under 2,300,000
finance lease
A piece of land owned whose title is leased to a third party under 1,502,300
operating lease
Land for undetermined future use 1,402,000
Property that is being developed for sale 1,200,000
Property owned used for administrative purposes 1,000,000
Total P 21,504,300

After your audit, what amount should be presented as part of investment property and
owner occupied property in ABC Company’s statement of financial position?

Prepare adjusting entries to correct the misclassification of various properties in the

books of ABC Company. (Assuming lease payments totaling P1,000,000 for the property
leased out under finance lease are recorded as rental income and depreciation already
ceased upon inception of the lease)

Problem 1-6: Investment Property and Owner Occupied Property

The consolidated statement of financial position of Pepe’ Le Pew Company and

subsidiaries provides the following information in relation to its Investment Property as of
December 31, 2014:

Property held by a subsidiary of Pepe’ Le Pew, a real estate firm, in

the ordinary course of business P 3,500,000
Land held by Pepe’ Le Pew for undetermined use 4,350,000
Property under construction for use as investment property 6,700,000
Land held for future use as factory site 5,200,000
Building awaiting disposal 1,120,000
Machinery leased out by Pepe’ Le Pew to a third party under an
operating lease 590,000
Equipment leased out by Pepe’ Le Pew to a third party under a finance
lease 710,000
Machinery awaiting disposal 345,000
Building owned by a subsidiary of Pepe’ Le Pew and for which the 3,890,100

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-3
 subsidiary provides security and maintenance services to the lessees
Land leased by Pepe’ Le Pew to a subsidiary under an operating lease 2,200,000
Land leased by Pepe’ Le Pew to a subsidiary under a finance lease 2,340,000
A vacant building owned by Pepe’ Le Pew and to be leased out under
an operating lease 5,500,000
Property held by Pepe’ Le Pew for use in production 1,750,000
Building held by Pepe’ Le Pew under a finance lease currently being
leased out to a third party 4,150,000
Property leased by Pepe’ Le Pew from its subsidiary under a finance
lease 5,263,000
Property being constructed on behalf of Sniffles, an outside company 2,400,000
Total Investment Property P 50,008,100

Required:

Compute for the correct balance of Investment Property to be reflected in the

consolidated statement of financial position of Pepe’ Le Pew Company and subsidiaries
as of December 31, 2014.

Problem 1- 7: Initial Recognition of Investment Property, Various Measurement Issues

Yu, Wei, Sy & Co., a public accounting firm, is engaged to audit Spy Company, a family
owned corporation. During the year, they entered into the following transactions:

 On January 10, 2014, the Company purchased a building for undetermined future
use amounting to P10,520,000. Incidental costs incurred for the acquisition
amounted to P123,000.

 On February 8, 2014, the Company exchanged an owner-occupied property with cost

and accumulated depreciation amounting to P20,000,000 and P542,000,
respectively, for a land and building with combined fair value of P27,420,800
primarily held for capital appreciation. The exchange is considered to be of
commercial substance.

 On March 15, 2014, the Company exchanged another owner occupied property with
carrying value of P22,380,000 for a land with undetermined future use. The
exchange is without commercial substance.

 On June 30, 2014, it purchased a piece of property (land and building) at an

installment price of P100 million. The appraised value of land and building are
P30,000,000 and P40,000,000, respectively. The Company made a down-payment
of 10%, and issued a non-interest bearing note payable at the end of each year for 9
years (P10 million each). As of the transaction date, the market rate for 9 years is
12%. Annual real property tax of P100,000 was assumed by the Company. Apart
from this, the YWS Company also paid broker’s commission, legal costs, and other
direct taxes amounting to P50,000.

 On December 1, 2014, the Company issued 20,000 of its own capital stock in
exchange of a building to be leased out under operating leases. The par value and
market value per share amounted to P30 and P120, respectively.

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-4
Required:

a. Prepare the journal entries to record the enumerated transactions.

b. For purposes of the December 31, 2014 statement of financial position, what is the
carrying value of the investment property (assuming the initial acquisition cost is
still the fair value as of year-end)?

Problem 1-8: Subsequent Measurement after Acquisition; Change in measurement

model

Captain Barbel & Co. is the external auditor of Green Lantern Inc. During the audit
fieldwork, it was found out that the client’s investment property is still carried at its initial
cost of P2,400,000. The said property was acquired last June 30, 2014. Further
examination disclosed the following:

Fair Value as of 12/31/2014 P2, 600,000

Useful Life 8 years

Required:

a. Assuming the fair value model was used, how much is the carrying value of the
investment property as of December 31, 2014? How much gain (income)/loss
(expense) should be recognized in profit or loss?
b. Assuming the cost model was used, how much is the carrying value of the
investment property as of December 31, 2014? Will there be any gain (income)/
loss (expense) to be recognized in profit or loss?
c. Assuming the fair value of the property as of 12/31/2015 permanently declined to
P1,500,000:
a. How much loss should be recognized under the fair value model?
b. How much loss should be recognized under the cost model?
c. How much is the carrying amount of the investment property under fair
value model? Cost model?

Problem 1 – 9: Disposal and Derecognition of Investment Property and Related

Gain/Loss on Disposal

On June 30, 2014, Valor Company sold its investment property for P16,255,000 net of
transaction costs amounting to P155,000. The property was initially acquired at a cost of
P12,250,000 excluding transaction cost of P125,000. Useful life is estimated to be 10
years. The property is already held by the Company as investment property for 2 years.
Since last re-measurement date, the fair value of the investment property P16,150,000.

Required:

a. Under fair value model, how much gain/loss on sale should be recognized by the
Company?
b. Under cost model, how much gain/loss on sale should be recognized?
c. Ignoring the effect of deprecation, prepare an analysis showing the total impact of
all investment property related transactions on Valor Company’s net income for
the period ended December 31, 2014 under (a) fair value model and (b) cost
model.

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-5
Problem 1 – 10: Transfers from/into Investment Property, Various Measurement Issues

Consider the following independent cases:

a. DBS Corporation, real estate developer, acquired investment property at a total

cost of P5,000,000. The investment property is accounted for under the fair value
model. At December 31, 2014, fair value of the investment property is
P6,500,000.

On March 30, 2014, DBS Corporation decided to use the property for their
operations. The fair value of the investment property amounted to P6,700,000 at
conversion date.

Required:
 Prepare necessary journal entries to record the conversion
 Assuming value at conversion date amounted to P4,800,000, what are the
entries to record the transfer?

b. Banihit Corporation acquired a land primarily used for operations at a total cost of
P5,000,000. On March 30, 2014, Banihit Corporation decided to hold the land for
capital appreciation. The fair value of the investment property amounted to
P6,700,000 at conversion date.

Per Company’s existing accounting policies, the investment property should be

carried at fair value.

Required:
 Prepare necessary journal entries to record the conversion
 Assuming value at conversion date amounted to P4,800,000, what are the
entries to record the transfer?

c. Acosta Corporation, real estate developer, acquired investment property at a total

cost of P5,000,000. The investment property is accounted for under the cost
model. On March 30, 2014, Acosta Corporation decided to use the property for
their operations. The fair value of the investment property declined to P4,700,000
at conversion date.

Required:
 Prepare necessary journal entries to record the conversion
 Assuming the property was initially classified as owner-occupied property,
prepare necessary journal entries to record the conversion

Problem 1-11: Audit Working Paper Preparation

SPA & Company was appointed as the auditor of DMCG Corporation for the year ended
December 31, 2014. Upon examination of the 2010 audited financial statements, the
balance presented under investment property totaled P34,382,665. However, the audit
team noted that the beginning balance per general ledger amounted to P26,280,665.
Review of prior year working papers revealed the following:

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-6
 a. Beginning balance per books and per audit as of January 1, 2013 amounted to
P18,380,775.

b. The client-corporation committed various errors in the recording of newly

acquired investment properties. Test of additions working paper contains the
following:

Property Initial Cost Transaction Costs Amount Capitalized Outstanding

Payable
Land 1 P4,820,000 P180,000 P4,820,000 3,200,000
Land 2 5,222,000 130,000 5,352,000 4,852,000
Bldg 1 3,920,000 80,000 4,720,000 2,800,000
Bldg 2 8,965,000 150,000 9,115,000 8,900,000
Total 22,927,000 540,000 24,007,000 19,752,000

c. Working paper on test of disposal disclosed the following information:

Property Cost Valuation Derecognized Recognized

Adjustment Value Gain/(Loss)
Land 3 1,300,000 (100,000) 1,300,000 500,000
Land 4 2,300,000 (700,000) 1,600,000 200,000
Bldg 3 4,000,000 780,000 4,000,000 (200,000)
Bldg 4 2,800,000 (100,000) 2,700,000 300,000
Total 10,400,000 (120,000) 9,600,000 800,000

d. Test of valuation working paper showed that fair value loss amounting to
P6,507,110 was booked by the client-corporation while fair value gain were still
unrecorded.

e. Apart from those mentioned above, no other transactions affected the investment
property account.

Required:

(a) Prepare an audit working paper to reconcile the beginning balance of investment
property per books and the final prior year audited balance. Indicate the adjusting
journal entries to be proposed for purposes of the current year audit.

(b) Answer the following:

a. How much is the carrying amount of the investment property prior to
valuation adjustment?
b. How much is the correct balance of realized gain or loss on disposal of
investment property?
c. How much is the unrecorded fair value gains in the books of the
Company?

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-7
PART II: NONCURRENT ASSETS HELD FOR SALE AND DISCONTINUED
OPERATIONS

Discussion Questions 1-1: Nature of Noncurrent Assets Held for Sale and Discontinued
Operations

1. Define the following terms:

a. Noncurrent assets held for sale
b. discontinued operation
c. component of an entity
2. What are the initial recognition criteria noncurrent assets held for sale? How
should it be measured initially and subsequently?
3. If a noncurrent asset (or disposal group) is to be abandoned, can it be classified
as held-for-sale in accordance with PFRS 5? What if the said abandoned
property is also a discontinued operation, can it be classified as such in
accordance with PFRS 5?

Problem 1-1: Classifying assets as held for sale

Sir Cheng, Inc. is committed to a plan to sell its headquarters building and has initiated
actions to locate a buyer.

Required:
Under each condition, determine whether it can be classified as held for sale or not.

a. SCI intends to transfer the building to a buyer after it vacates the building. The time
necessary to vacate the building is usual and customary for sales of such assets.
b. SCI will continue to use the building until construction of a new headquarters building
is completed. The entity does not intend to transfer the existing building to a buyer
until after construction of the new building is completed (and it vacates the existing
building).
Problem 1-2: Timing of Recognition of Noncurrent Assets Held for Sale and Presentation
of Discontinued Operations

JK Company is a wholly owned subsidiary of a Group that manufactures footwear. It

follows the calendar year for financial reporting. JK Company has two manufacturing
plant facilities, namely leisure flip flops segment and athletic rubber shoes segment.
This footwear Company has been running in the red brought about by the flooding of
cheap footwear imported from China and increased production costs in Marikina due to
inflation rates. Therefore, following a special meeting on January 15, 20x0, the Group’s
management, Board of Directors and stockholders decided to dissolve JK Company in
the following manner:

1. The athletic rubber shoes plant is to be sold to a local competitor. The company
has initiated an active program to locate the buyer. The Company currently has a
commitment to supply fifty (50) pairs of basketball rubber shoes to DLSU’s Green
Archer Team before the start of the UAAP season, May 31, 20x0. This
commitment is required before transfer of assets maybe fulfilled;
2. The leisure flip flops plant is to be abandoned on April 30, 20x0 due to lack of
active market of its identifiable assets. This segment will continue to fulfill existing
orders and collect debtors, but will not accept any new orders.

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-8
Required:

a. What date can the Athletic Rubber Shoes asset segment be classified as
Noncurrent Asset Held for Sale? What period (from January 1 to which date)
would the Income Statement cover the related discontinued operations of this
segment?

b. What date can the Leisure flip flop asset segment be classified as Noncurrent
Asset Held for Sale? What period (from January 1 to which date) would the
Income Statement cover the related discontinued operations of this segment?

Problem 1-3: Noncurrent assets held for sale, measurement issues

On June 1, 2013, Mariano Corporation has a building with a cost of P40,000,000 and
accumulated depreciation of P31,000,000. The company commits to plan to sell the said
asset by January 1, 2014. On June 1, 2013, estimated selling price is P7,000,000 (gross
of 5% selling costs of net selling price). On December 31, 2013, the estimated selling
price of the said asset has increased to 7,500,000 (net of 5% selling costs).

Required:
a. At the time of recognition of noncurrent assets held for sale, what amount should
the noncurrent asset held for sale be recognized?
b. What amount of loss should be recognized at the time of reclassification?
c. As of December 31, 2013, what is the carrying value of the noncurrent asset held
for sale
d. On December 31, 2013, what amount of gain or remeasurement should be
recognized?

Problem 1-4: Disposal Group as Held for Sale; Measurement issues

Reyes Inc. plans to sell a group of its assets and classifies it as held for sale. The
following assets form the disposal group:

Goodwill P 4,000,000
Property Plant and Equipment, carried at fair value 9,000,000
Property Plant and Equipment, at depreciated amount 2,000,000
Inventory 4,400,000
Investment in available for sale 3,600,000
Total 23,000,000

Net Realizable value of the inventory is estimated to be P400,000 lower than the carrying
amount and that the remeasured value of the property plant and equipment carried at fair
value is P8,000,000. Reyes Inc. estimates that the fair value less costs to sell of the
group amounts to P16,200,000.

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-9
The Company’s Accountant allocated Impairment loss as follows:

Goodwill P 1,182,609
Property Plant and Equipment, carried at fair value 2,660,870
Property Plant and Equipment, at depreciated amount 591,304
Inventory 1,300,870
Investment in available for sale 1,064,347
Total 6,800,000

Required:
a. Is the allocation made by the Company correct as to impairment loss?
b. What amount of loss to be recognized before classification as held for sale?
c. What amount of loss to be recognized after classification as held for sale?
d. Prepare a working paper to show the allocation of impairment loss
e. Prepare compound entry to correct the allocation of impairment loss

Problem 1-5: Noncurrent Asset Held For sale, Extended Period

On July 20x1, OP Company is committed to a plan to sell a disposal group that

represents a significant portion of its regulated operations. The sale requires regulatory
approval, which could extend the period required to complete the sale beyond one year.
Actions necessary to obtain that approval cannot be initiated until after a buyer is known
and a firm purchase commitment is obtained. However, a firm purchase commitment is
highly probable within one year. The noncurrent assets of disposal group have a
carrying value of P4 million and liabilities of P1 million. The total fair market value as of
December 31, 20x1 of the disposal group is P4.8 million. If the sale is completed within
one year, the estimated cost to sell is P200,000 but if the sale will extend beyond one
year, the present value of the estimated cost to sell is P180,000.

Required: If the sale will extend beyond one year, what amount of noncurrent asset
should OP Company report its held for sale property at December 31, 20x1?

Problem 1-6_Discontinued Operations

On June 1, 20x1, AGI committed to sell one of its geographical segments which can be
clearly distinguished, operationally and for financial reporting purposes, from the rest of
the company. This is expected to be finalized on January 20, 20x2. On December 31,
20x1, the carrying value of the segment is P3,000,000 and the fair value less cost to sell
is P2,800,00. During 20x1, severance and relocation costs amounting to P200,000 was
incurred due to the discontinued operations. Revenues and expenses relating to the
discontinued segment during 20x1 were as follows:

Revenues Expenses
January 1 to June 1 3,000,000 5,000,000
June 1 to December 31 1,200,000 1,600,000

Initial draft of financial statements showed that the loss from discontinued activities only
amounted to P800,000, gross of tax. Corporate tax rate is 30%.

Required: Compute for the following amounts:

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-10
 a. Prepare a working paper to outline the amount of loss to be reported from
discontinued activities.
a. Carrying value of the discontinued segment as of December 31, 20x1
b. Loss from ordinary activities of the discontinued segment
b. Difference, if there are any, between loss per audit and loss per initial draft
financial statements shall be reconciled. What is the most probable cause of the
committed error?

Auditing Practice II Third Term, AY 2013-2014

Workbook Page 1-11