CPA REVIEW SCHOOL OF THE PHILIPPINES AP-PW 91

Manila

AUDITING PROBLEMS CPA Review

REVIEW PROBLEMS-1

TONGCO COMPANY

TONGCO COMPANY decided on January 2, 2022, to review its accounting practices. This is due
to changing economic conditions and to make its financial statements more comparable to those
of other companies in its industry.

The following changes will be effective as of January 1, 2022:

1. Tongco decided to change its allowance for bad debts from 2% to 4% of its outstanding
receivables balance. Tongco’s receivable balance at December 31, 2022, was P690,000.
Allowance for bad debts had a debit balance of P2,000 before adjustment.

2. Tongco decided to use the straight-line method of depreciation on its equipment instead of
the sum-of-the-years’-digits method. It was also decided that this asset has 10 more years
of useful life as of January 2, 2022. The equipment was purchased on January 1, 2012, at a
cost of P1,100,000. On the acquisition date, it was estimated that the equipment would have
a 15-year useful life with no residual value.

1. The entry to record the current year provision for bad debts is
A. Bad debt expense 29,600
Allowance for bad debts 29,600
B. Allowance for bad debts 29,600
Bad debt expense 29,600
C. Bad debt expense 25,600
Allowance for bad debts 25,600
D. Allowance for bad debts 25,600
Bad debt expense 25,600
2. What is the amount of depreciation on equipment for the current year?
A. P45,833 C. P13,750
B. P9,167 D. P32,083

ANTIGO CORP.

The retained earnings account of ANTIGO CORP. is reproduced below:

RETAINED EARNINGS

Date Item Debit Credit

2020
Jan. 1 Balance P81,000
Dec. 31 Net income for year 18,000
2021
Jan. 10 Dividends paid P15,000
Mar. 6 Stock sold - excess over par 32,000
Dec. 31 Net loss for year 11,200
2022
Jan. 9 Dividends paid 15,000
Dec. 31 Balance 89,800
P131,000 P131,000

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The audit of the December 31, 2022, financial statements of the company reveals the following:

a. Dividends declared on December 10, 2020 and 2021 had not been recorded in the books until
paid.

b. Improvements in buildings and equipment of P9,600 had been charged to expense at the end
of April 2019. Improvements are estimated to have an 8-year life. Antigo computes
depreciation to the nearest month and uses the straight-line depreciation.

c. The physical inventory of merchandise had been understated by P3,000 at the end of 2020,
and by P4,300 at the end of 2021.

d. Merchandise in transit and to which the company had title at December 31, 2021 and 2022
was not included in the year-end inventories. These shipments of P3,800 and P5,500 were
recorded as purchases in January of 2022 and 2023, respectively.

e. The company had failed to record sales commissions payable of P2,100 and P1,700 at the
end of 2021 and 2022, respectively.

f. The company had failed to recognize supplies on hand of P1,200 and P2,500 at the end of
2021 and 2022, respectively.

g. The company reported a net loss of P12,400 for the year ended December 31, 2022.

1. Prepare the necessary adjusting journal entries at December 31, 2022.

2. What is the corrected net loss of Antigo Corp. for the year ended December 31, 2022?
A. P7,600 C. P6,000
B. P17,000 D. P16,200

PELU COMPANY

In the past, PELU COMPANY has depreciated its computer hardware using the straight-line
method. The computer hardware has a 10% salvage value and an estimated useful life of 5
years. As a result of the rapid advancement in information technology, management of Pelu has
determined that it receives most of the benefits from its computer facilities in the first few years
of ownership. Hence, as of January 1, 2022, Pelu proposes changing to the sum-of-the-years’-
digits method for depreciating its computer hardware. The following computer purchases were
made by Pelu at the beginning of each year.

2019 P90,000
2020 50,000
2021 60,000

1. How much depreciation expense was recorded by Pelu in 2019, 2020, and 2021?

2019 2020 2021

A. P18,000 P28,000 P40,000
B. 36,000 36,000 36,000
C. 16,200 36,000 36,000
D. 16,200 25,200 36,000

2. The amount of depreciation expense that should be recognized in 2022 is

A. P21,240 C. P52,3801
B. P63,280 D. P34,200

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POHNPEI CORP.

You have been engaged to audit the financial statements of POHNPEI CORP. for the year ended
December 31, 2022. Your audit reveals the following situations:

1. Depreciation of P16,000 for 2022 on equipment was not recorded.

2. The physical inventory count on December 31, 2021, improperly excluded merchandise
costing P95,000 that had been temporarily stored in a public warehouse. Pohnpei uses a
periodic inventory system.

3. The physical inventory count on December 31, 2022, improperly included merchandise with
a cost of P42,500 that had been recorded as a sale on December 29, 2022, and held for the
customer to pick up on January 2, 2023.

4. A collection of P28,000 on account from a customer received on December 31, 2022, was
not recorded until January 3, 2023.

5. In 2022, Pohnpei sold for P18,500 fully depreciated equipment that originally cost P110,000.
The proceeds from the sale were credited to the Equipment account.

6. During December 2022, a competitor company filed a patent-infringement suit against

Pohnpei claiming damages of P1,000,000. The company’s legal counsel has indicated that
an unfavorable outcome is probable and a reasonable estimate of the court’s award to the
competitor is P600,000. The company has not reflected or disclosed this situation in the
financial statements.

7. Pohnpei has a portfolio of current marketable equity securities acquired in 2021 for trading
purposes. No valuation entry has been made. Information on cost and market value is as
follows:
Cost Market
December 31, 2021 P475,000 P475,000
December 31, 2022 P475,000 P500,000

8. At December 31, 2022, an analysis of payroll information shows accrued salaries of P61,000.
The Accrued Salaries Payable account had a balance of P80,000 at December 31, 2022,
which was unchanged from its balance at December 31, 2021.

9. A piece of equipment was acquired on January 2, 2022, for P160,000 and was charged to
Repairs Expense. The equipment is expected to have a useful life of 8 years and no residual
value. Pohnpei normally uses the straight-line method to depreciate this type of equipment.

10. A P75,000 insurance premium paid on July 1, 2021, for a policy that expires on June 30,
2024, was charged to Insurance Expense.

11. A patent was acquired at the beginning of 2021 for P250,000. No amortization has been
recorded since its acquisition. The patent had a 10-year useful life on the date of acquisition.

Required:
Prepare the necessary adjusting journal entries at December 31, 2022. Ignore income tax
considerations.

ISRAEL COMPANY

ISRAEL COMPANY is authorized to issue 200,000 of P10 par value ordinary shares, and 60,000 of
6% cumulative and nonparticipating preference shares, par value P100 per share. The company
engaged in the following share capital transactions through December 31, 2022:

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a) 50,000 ordinary shares were issued for P650,000 and 20,000 preference shares for machinery
valued at P2,600,000.
b) Subscriptions for 9,000 ordinary shares have been taken, and 40% of the subscription price
of P18 per share has been collected. The shares will be issued upon collection of the
subscription price in full.
c) 2,000 treasury ordinary shares have been purchased for P12 and accounted for under the
cost method.
The post-closing retained earnings balance at December 31, 2022, is P420,000.

What is Israel’s total shareholders’ equity at December 31, 2022?

A. P3,714,800 C. P3,638,800
B. P3,710,800 D. P3,110,800

EVERLASTING COMPANY

Your firm is currently conducting the audit of EVERLASTING COMPANY’s financial statements for
the year ended May 31, 2022. You are now concentrating on the review of the working papers
prepared by your staff where possible adjusting journal entries may be drafted to arrive at the
adjusted balances of the accounts that may be affected.

Working Paper No. 1

CASH – BPI
Bank Reconciliation
May 31, 2022
Balance per bank statement P7,823,170
Add (deduct) reconciling items:
Deposit in transit (Note 1) 93,812
Outstanding checks (Note 2) (108,832)
Note charged by the bank (Note 3) 41,850
Fund transfer from PNB (12,500)
Balance per general ledger P7,837,500
The top schedule for Cash showed the following accounts with their unadjusted balances:
Cash – BPI P7,837,500
Cash – PNB 112,500
Cash – SB 187,500
Total P8,137,500

Audit Notes:
1. Inclusive of a customer’s check in the amount of P18,750 (under “over 90 days” category)
dated April 25, 2022, which up to now is not yet deposited because it has been misplaced.
2. Includes two checks totaling P14,354 which were among the items counted during the cash
count conducted early morning of June 1, 2022.
3. This is the maturity value of a two-year note maturing on May 31, 2022. The note bears
interest of 12%. Interest for the year ended May 31, 2021, was properly accrued.
4. Upon cross-referencing this with the working paper showing the bank reconciliation with PNB,
whereby the bank balance was reconciled with the general ledger balance, you verified that
the P12,500 was appropriately shown as an addition to the bank balance.

Working Paper No. 2

ACCOUNTS RECEIVABLE
Reconciliation Between Subsidiary Ledger and General Ledger Balances
May 31, 2022
Balance per subsidiary ledger P4,023,527
Add (deduct) reconciling items:

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Write-offs (See Working Paper No. 3) (187,608)

Sales (Note 5) 61,250
Collections (Note 6) 36,845
Balance per general ledger P3,934,014
The company maintains a credit term of n/30.

Audit Notes:
5. The goods were in transit as at May 31, 2022, terms FOB shipping point. The company
recognized a gross profit of 25% on this sale.
6. This was collected from a customer by the company’s branch on May 31, 2022, on sales made
on March 25, 2022, and was remitted to the company on June 15, 2022. Collections from
branches are charged to Cash–SB account.

Working Paper No. 3

ALLOWANCE FOR BAD DEBTS
May 31, 2022
Balance, June 1, 2021 P407,500
Add (deduct) transactions during the year:
Write-offs of accounts aged 5 years (187,608)
Bad debt provision for the year 108,930
Balance, May 31, 2022 P328,822

Based on the company’s past experience, an allowance should be set up based on the following
rates:
Aging Distribution Per Subsidiary Ledger Percentage
Current P868,845 2
Past due:
1 – 30 808,670 5
31 – 60 718,853 10
61 – 90 737,225 15
Over 90 889,934 20
Total P4,023,527

Based on the preceding information, determine the adjusted balances of the following:
1. Cash in banks
A. P8,128,099 B. P8,165,599 C. P8,091,254 D. P8,140,599
2. Accounts receivable
A. P3,854,669 B. P3,915,919 C. P3,879,074 D. P3,878,419
3. Allowance for bad debts
A. P385,720 B. P605,612 C. P793,220 D. P328,822
4. The principal amount of the 12% two-year note payable
A. P37,800 B. P41,850 C. P33,750 D. P1,850
5. Cash in bank - BPI
A. P7,778,754 B. P7,803,754 C. P7,788,734 D. P7,812,546

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REVIEW PROBLEMS-2
COLOONG CO.

COLOONG CO. holds debt securities within a business model whose objective is achieved both by
collecting contractual cash flows and selling the debt securities. The contractual cash flows are
solely payments of principal and interest on specified dates.

The following amortization schedule relates to its 5-year, P1,000,000, 7% bonds purchased on
December 31, 2019, for P1,086,565. The bonds were purchased to yield 5% interest.

Interest Interest Premium Amortized

Date Received Income Amortization Cost
12.31.19 P1,086,565
12.31.20 P 70,000 P 54,328 P 15,672 1,070,893
12.31.21 70,000 53,545 16,455 1,054,438
12.31.22 70,000 52,722 17,278 1,037,160
12.31.23 70,000 51,858 18,142 1,019,018
12.31.24 70,000 50,982* 19,018 1,000,000

*Adjustment due to rounding

The following schedule presents the amortized cost and fair value of the bonds at year-end.
Fair Value Amortized Cost
December 31, 2020 P1,065,000 P1,070,893
December 31, 2021 1,075,000 1,054,438
December 31, 2022 1,056,500 1,037,160
December 31, 2023 1,030,000 1,019,018
December 31, 2024 1,000,000 1,000,000

Questions:

1. What amount should be reported as investment in bonds in the statement of financial

position of Coloong Co. on December 31, 2021?
A. P1,054,438 B. P1,065,000 C. P1,075,000 D. P1,086,565

2. What amount of unrealized gain should be shown as component of other comprehensive

income in the 2021 statement of comprehensive income?
A. P10,000 B. P16,455 C. P20,562 D. P26,455

3. What amount of unrealized loss should be shown as component of other comprehensive

income in the 2022 statement of comprehensive income?
A. P1,222 B. P14,393 C. P18,500 D. P19,340

4. What amount of unrealized loss should be shown as component of other comprehensive

income in the 2023 statement of comprehensive income?
A. P8,358 B. P9,792 C. P10,982 D. P26,500

5. What amount of unrealized gain should be shown in the 2023 statement of changes in
equity?
A. P10,982 B. P16,883 C. P25,233 D. P26,455

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SOMOSA COMPANY

The December 31 year-end financial statements of SOMOSA COMPANY contained the following
errors:
Dec. 31, 2021 Dec. 31, 2022
Ending inventory P48,000 understated P40,500 overstated
Depreciation expense P11,500 understated -------

An insurance premium of P330,000 was prepaid in 2021 covering the years 2021, 2022, and
2023. The entire amount was charged to expense in 2021. In addition, on December 31, 2022,
a fully depreciated machinery was sold for P75,000 cash, but the sale was not recorded until
2023. There were no other errors during 2021 and 2022, and no corrections have been made
for any of the errors. Ignore income tax effects.

1. What is the total effect of the errors on SOMOSA’s 2022 net income?
A. P123,500 overstatement
B. P27,500 overstatement
C. P192,500 understatement
D. P177,500 understatement

2. What is the total effect of the errors on the amount of SOMOSA’s working capital at December
31, 2022?
A. P75,500 overstatement
B. P40,500 overstatement
C. P225,500 understatement
D. P144,500 understatement

3. What is the total effect of the errors on the balance of SOMOSA’s retained earnings at
December 31, 2022?
A. P156,000 understatement
B. P87,000 overstatement
C. P133,000 understatement
D. P85,000 understatement

BUTIKI CO.

The first audit of the financial statements of BUTIKI CO. was made for the year ended December
31, 2022. In reviewing the books, the auditor found out that certain adjustments had been
overlooked at the end of 2021 and 2022. He also discovered that other items had been improperly
recorded. These omissions and other failures for each year are summarized as follows:
RE 145 600
December 31 Salaries pay 15 000
2021 2022 Salaries exp 130 000

Salaries payable 145,600 130,000 Int exp 7700

Interest receivable 43,200 35,500 Int rec 35 500
RE 43 200
Prepaid insurance 64,000 51,300
Advances from customers(1) 78,400 93,500 Prepaid in 51300
Equipment(2) 94,000 87,000 In exp 12 700
RE 64 000
RE 78 400
(1)
Collections from customers had been recorded as sales but should have been recognized as Sales 15 100
advances from customers because goods were not shipped until the following year. ADv 93500

(2)
Capital expenditures had been recorded as repairs but should have been charged to
equipment; the depreciation rate is 10% per year, but depreciation in the year of the
expenditure is to be recognized at 5%. Eq 181 000 RE 4700
Repairs 87 000 Dep exp 13 750
RE 94 000 AD 18 450

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Required:
Assuming that the nominal accounts for 2022 have not yet been closed into the income summary
account, prepare all the necessary adjusting journal entries on December 31, 2022.

FRANCISCO CORPORATION

Information concerning FRANCISCO CORPORATION’s intangible assets is as follows:

1. On January 1, 2022, Francisco signed an agreement to operate as a franchisee of Kopya Copy

Service, Inc. for an initial franchise fee of P8,500,000. Of this amount, P2,500,000 was paid
when the agreement was signed and the balance is payable in four annual payments of
P1,500,000 each beginning January 1, 2023. The agreement provides that the down payment
is not refundable and no future services are required of the franchisor. The implicit interest
rate for a loan of this type is 14%. The agreement also provides that 5% of the revenue from
the franchise must be paid to the franchisor annually. Francisco’s revenue from the franchise
for 2022 was P9,000,000. Francisco estimates the useful life of the franchise to be ten years.

2. Francisco incurred P7,800,000 of experimental and development costs in its laboratory to

develop a patent which was granted on January 2, 2022. Legal fees and other costs associated
with registration of the patent totaled P1,640,000. Francisco estimates that the useful life of
the patent will be 8 years.

3. A trademark was purchased from Banawe Company for P4,000,000 on July 1, 2019.
Expenditures for successful litigation in defense of the trademark totaling P1,000,000 were
paid on July 1, 2022. Francisco estimates that the useful life of the trademark will be 20 years
from the date of acquisition.

4. During the current year, Francisco incurred the following costs to develop and produce a
routine, low-risk computer software product.

Completion of detailed program design P3,900,000

Costs incurred for coding and testing to establish technological
feasibility 3,000,000
Other coding costs after establishment of technological feasibility 7,200,000
Other testing costs after establishment of technological feasibility 6,000,000
Costs of producing product masters 4,500,000
Duplication of computer software (3,000 units) 7,500,000
Packaging product (1,500 units) 2,700,000

Questions:

1. What is the carrying value of the franchise at December 31, 2022?

A. P3,933,508 B. P7,650,000 C. P6,870,565 D. P6,183,509

2. What is the carrying value of the patent at December 31, 2022?

A. P1,640,000 B. P6,825,000 C. P1,435,000 D. P5,390,000

3. What is the carrying value of the trademark on December 31, 2022?

A. P3,400,000 B. P4,000,000 C. P3,300,000 D. P3,800,000

4. What is the initial cost of the computer software?

A. P17,700,000 B. P21,600,000 C. P10,200,000 D. P12,900,000

5. The total expenses resulting from the transactions that would appear on Francisco’s income
statement for the year ended December 31, 2022, should be
A. P17,553,935 B. P10,053,935 C. P9,053,935 D. P9,442,056

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ENTITY A

At the beginning of year 1, Entity A grants 100 shares each to 500 employees, conditional upon
the employees remaining in the entity’s employ during the vesting period.

The shares will vest at the end of year 1 if the entity’s earnings increase by more than 18 percent;
at the end of year 2 if the entity’s earnings increase by more than an average of 13 percent per
year over the two-year period; and at the end of year 3 if the entity’s earnings increase by more
than an average of 10 percent per year over the three-year period.

The shares have a fair value of P30 per share at the start of year 1, which equals the share price
at grant date.

By the end of year 1, the entity’s earnings have increased by 14 percent, and 20 employees have
left. The entity expects that earnings will continue to increase at a similar rate in year 2, and
therefore expects that the shares will vest at the end of year 2. The entity expects, on the basis
of a weighted average probability, that a further 30 employees will leave during year 2.

By the end of year 2, the entity’s earnings have increased by only 10 percent and therefore the
shares do not vest at the end of year 2. 42 employees have left during the year. The entity
expects that a further 15 employees will leave during year 3, and that the entity’s earnings will
increase by at least 6 percent, thereby achieving the average 10 percent per year.

By the end of year 3, 10 employees have left and the entity’s earnings had increased by 8 percent.

1. What amount of compensation expense should be recognized in year 1? 675 000

2. What amount of compensation expense should be recognized in year 2? 171 000
3. What amount of compensation expense should be recognized in year 3? 438 000

ENTITY B

At the beginning of year 1, Entity B grants to a senior executive 3,000 share options, conditional
upon the executive remaining in the entity’s employ until the end of year 3. The exercise price
is P40. However, the exercise price drops to P30 if the entity’s earnings increase by at least an
average of 10 percent per year over the three-year period.

On grant date, the entity estimates that the fair value of the share options, with an exercise price
of P30, is P15 per option. If the exercise price is P40, the entity estimates that the share options
have a fair value of P12 per option.
During year 1, the entity’s earnings increased by 12 percent, and the entity expects that earnings
will continue to increase at this rate over the next two years. The entity therefore expects that
the earnings target will be achieved, and hence the share options will have an exercise price of
P30.

During year 2, the entity’s earnings increased by 13 percent, and the entity continues to expect
that the earnings target will be achieved.

During year 3, the entity’s earnings increased by only 3 percent, and therefore the earnings target
was not achieved. The executive completes three years’ service, and therefore satisfies the
service condition. Because the earnings target was not achieved, the 3,000 vested share options
have an exercise price of P40.

1. What is the compensation expense in year 2? 15 000

2. What is the compensation expense in year 3? 6 000

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