AUDIT OF LIABILITIES

(EXPENDITURE AND FINANCING CYCLE)

Problem 1

Dallas Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31. The following information relates to the
obligations of the company as of March 31, 2020:

Notes payable
Dallas has signed several notes with financial institutions. The maturities of these notes are given below. The total unpaid interest for all of these
notes amounts to P340,000 on March 31, 2020.

Due date Amount

April 31, 2020 P 700,000
July 31, 2020 900,000
February 1, 2021 800,000
April 30, 2021 1,200,000
June 30, 2021 1,500,000
P 5,100,000

Estimated warranties
Dallas has a one-year product warranty on some selected items. The estimated warranty liability on sales made during the 2018 – 2019 fiscal year
and still outstanding as of March 31, 2019, amounted to P252,000. The warranty costs on sales made from April 1, 2019 to March 31, 2020, are
estimated at P630,000. The actual warranty costs incurred during 2019 – 2020 fiscal year are as follows:

Warranty claims honored on 2018 – 2019

sales P 252,000
Warranty claims honored on 2019 – 2020
sales 285,000
Total P 537,000

Trade payables
Accounts payable for supplies, goods, and services purchases on open account amount to P560,000 as of March 31, 2020.

Dividends
On March 10, 2020, Dallas’ board of directors declared a cash dividend of P0.30 per ordinary share and a 10% ordinary share dividend. Both
dividends were to be distributed on April 5, 2020 to ordinary shareholders on record at the close of business on March 31, 2020. As of March 31,
2020, Dallas has 5 million, P2 par value, ordinary shares issued and outstanding.

Bonds payable
Dallas issued P5,000,000, 12% bonds, on October 1, 2014 at 96. The bonds will mature on October 1, 2024. Interest is paid semi-annually on
October 1 and April 1. Dallas uses the straight line method to amortize bond discount.

Based on the foregoing information, determine the adjusted balances of the following as of March 31, 2020:

1. Estimated warranty payable

2. Total current liabilities

3. Trade and other payables

4. Total noncurrent liabilities

5. In auditing accounts payable, an auditor’s procedures most likely will focus primarily on management’s assertion of
a. Existence c. Completeness
b. Presentation and disclosure d. Valuation

6. Which of the following procedures is least likely to be performed before the balance sheet date? a. Observation of inventory
b. Testing of internal control over cash
c. Search for unrecorded liabilities
d. Confirmation of receivables

7. Unrecorded liabilities are most likely to be found during the review of which of the following documents?
a. Unpaid bills
b. Bills of lading
c. Shipping records
d. Unmatched sales invoices

8. An auditor’s purpose in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to obtain evidence
concerning management’s assertions about a. Existence or occurrence
b. Presentation and disclosure
c. Valuation or allocation
d. Completeness

Problem 2

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Relevant extracts from Magic Corporation’s financial statements at 31 December 2019 are as follows:

Current liabilities
Provision for warranties P405,000

Non-current liabilities
Provision for warranties 270,000

Note 10 - Contingent liabilities

Magic is engaged in litigation with various parties in relation to allergic reactions to traces of peanuts alleged to have been found in
packets of fruit gums. Magic strenuously denies the allegations and, as at the date of authorizing the financial statements for issue, is
unable to estimate the financial effect, if any, of any costs or damages that may be payable to the plaintiffs.

The provision for warranties at 31 December 2019 was calculated using the following assumptions: There was no balance carried forward from the
prior year.

Estimated costs of repairs - products with minor defects

P1,500,000
Estimated cost of repairs - products with major defects
P9,000,000
Expected % of products sold during 2019 having no defects in
2020 80%
Expected % of products sold during 2019 having minor defects in
2020 15%
Expected % of products sold during 2019 having major defects in
2020 5%
Expected timing of settlement of warranty payments - those
with minor defects All in 2020
Expected timing of settlement of warranty payments - those 40% in 2020,
with major defects 60% in 2021

During the year ended 31 December 2020 the following occurred:

1. In relation to the warranty provision of P675,000 at 31 December 2019, P300,000 was paid out of the provision. Of the amount paid,
P225,000 was for products with minor defects and P75,000 was for products with major defects, all of which related to amounts that had
been expected to be paid in 2020.

2. In calculating its warranty provision for 31 December 2020, Magic made the following adjustments to the assumptions used for the prior year:

Estimated cost of repairs - products

with minor defects No change
Estimated cost of repairs - products
with major defects P7,500,000
Expected % of products sold during
2020 having no defects in 2021 85%
Expected % of products sold during
2020 having minor defects in 2021 13%
Expected % of products sold during
2020 having major defects in 2021 2%
Expected timing of settlement of warranty payments - those with
minor defects All in 2021
Expected timing of settlement of 20% in warranty payments - those with
2021, 80% major defects in 2022

3. Magic determined that part of its plant and equipment needed an overhaul – the conveyer belt on one of its machines would need to be
replaced in about December 2021 at an estimated cost of P500,000. The carrying amount of the conveyer belt at 31 December 2020 was
P280,000. Its original cost was P400,000.

4. Magic was unsuccessful in its defense of the peanut allergy case and was ordered to pay P2,000,000 to the plaintiffs. As at 31 December 2020
Magic had paid P1,500,000.

5. Magic commenced litigation against one of its advisers for negligent advice given on the original installation of the conveyers’ belt referred to
in (4) above. In October 2020 the court found in favor of Magic. The hearing for damages had not been scheduled as at the date the financial
statements for 2020 were authorized for issue. Magic estimated that it would receive about P500,000.

6. Magic signed an agreement with Choko Bank to the effect that Magic would guarantee a loan made by Choko Bank to Magic's subsidiary, UN
Ltd. UN’s Ltd. loan with Choko Bank was P3,000,000 as at 31 December 2020. UN Ltd. was in a strong financial position at 31 December
2020.

Based on the above and the result of your audit, answer the following:

1. The warranty expense in 2020 is

2. The provision for warranties as of December 31, 2020 is

3. The provision for warranties to be reported as current liability as of December 31, 2020 is

4. The provision for warranties to be reported as noncurrent liability as of December 31, 2020 is

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5. Total provisions to be reported in the statement of financial position as of December 31, 2020 is

Problem 3

In your initial audit of Bulls Co., you find the following ledger account balances.

12%, 25-year Bonds Payable, 2016 issue

01/01/2016 CR P 1,600,000

Treasury Bonds
10/01/2020 CD P 216,000
Bond Premium
01/01/2016 CR P 80,000

Bond Interest Expense

01/01/2020 CD P 96,000
07/01/2020 CD 96,000

The bonds were redeemed for permanent cancellation on October 1, 2020 at 105 plus accrued interest.

Based on the above and the result of your audit, answer the following: (Use straight line amortization method)

1. The adjusted balance of bonds payable as of December 31, 2020 is

2. The unamortized bond premium on December 31, 2020 is

3. The total bond interest expense for the year 2020 is

4. The gain or loss on partial bond redemption is

5. An auditor’s program to audit long term debt should include steps that require
a. Examining bond trust indentures
b. Inspecting the accounts payable subsidiary ledger.
c. Investigating credits to the bond interest income account.
d. Verifying the existence of the bondholders.

6. In an audit of bonds payable, an auditor expects the trust indenture to include the
a. Auditee’s debt-to-equity ratio at the time of issuance.
b. Effective yield of the bonds issued.
c. Subscription list.
d. Description of the collateral

7. In auditing long-term bonds payable, an auditor most likely will

a. Perform analytical procedures on the bond premium and discount accounts.
b. Examine documentation of assets purchased with bond proceeds or liens
c. Compare interest with the bond payable amount for reasonableness.
d. Confirm the existence of individual bondholders at year-end.

8. Which of the following audit procedures is least likely to detect an unrecorded liability?
a. Analysis and recomputation of interest expense.
b. Mailing of standard bank confirmation forms.
c. Reading of the minutes of meetings of the board directors.
d. Analysis and recomputation of depreciation expense.

Problem 4

On January 1, 2019, Thunder Corporation issued 2,000 of its 5-year, P1,000 face value, 11% bonds dated January 1 at an effective annual interest
rate (yield) of 9%. Interest is payable each December 31. Thunder uses the effective interest method of amortization. On December 31, 2020, the
2,000 bonds were extinguished early through acquisition in the open market by Thunder for P1,980,000 plus accrued interest.

On July 1, 2019, Thunder issued 5,000 of its 6-year, P1,000 face value, 10% convertible bonds at par. Interest is payable every June 30 and
December 31. On the date of issue, the prevailing market interest rate for similar debt without the conversion option is 12%. On July 1, 2020, an
investor in Thunder’s convertible bonds tendered 1,500 bonds for conversion into 15,000 ordinary shares of Thunder, which had a fair value of
P105 and a par value of P1 at the date of conversion.

Based on the above and the result of your audit, determine the following: (Round off present value factors to four decimal places.)

1. The issue price of the 2,000 5-year, P1,000 face value bonds on January 1, 2019 is

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2. The carrying amount of the 2,000 5-year, P1,000 face value bonds on December 31, 2019 is

3. The gain on early retirement of bonds on December 31, 2020 is

4. The issuance of the 6-year, P1,000 face value bonds on July 1, 2019 increased equity by

5. The conversion of the 1,500 6-year, P1,000 face value bonds on July 1, 2020 increased share premium by

Problem 5

In the audit process, the following data were obtained from the books of the Spurs Company which uses a voucher system. All invoices are
subject to term 2/10, n/30 and are entered net with the discount entered in the Purchase Discount column of the voucher register. The accountant
in charge of the books went on leave to attend to his family based in New Jersey. A fresh accounting graduate has been assigned to record the
transactions. At year-end, the substitute accountant finds that the unpaid vouchers do not agree with the Vouchers Payable control account. You
are called to adjust the matter.

A schedule of unpaid vouchers as of December 31, 2015, all of which are net of discount, is presented to you:

Date Voucher No. Supplier Amount

Nov. 27 797 Duncan Supply Co. P 78,400
Dec. 02 821 Ginobili Distributors 19,600
11 829 Parker Sales 44,100
20 836 Mohamed Dealers 17,150
21 842 Bowen Merchandising 22,050
22 856 Horry Mercantile 80,850
31 865 Jackson Traders 78,400
P340,550

Vouchers Payable (control account)

Cash disbursements P1,309,500 Purchases journal P1,645,000
Purchase returns journal 36,750*

* Voucher Nos. 821 and 836 cancelled as goods were returned in December.

Based on the above and the result of your audit, compute for the following as of December 31, 2015:

1. Adjusted balance of Vouchers Payable

2. Purchase discounts lost on unpaid vouchers

3. Purchase discounts lost on paid vouchers

4. Adjusting journal entry or entries to correct the accounts will include

a. A debit to Purchase Discounts Lost of P11,250.
b. A debit to Purchase Discounts Lost of P5,050.
c. A credit to Vouchers Payable of P8,000.
d. A credit to Vouchers Payable of P11,250.

Problem 6

The following schedule of liabilities was provided to you by the accountant of JUANITO DESPACITO Inc. in line with your audit of its
various liabilities as of and for the period ended December 31, 2018:

Current Liabilities
Accounts Payable (note a) =P 534,000
Premiums Payable (note b) 242,000 =P 1,216,000

Noncurrent Liabilities
10%, Bonds payable (note c) =P 2,000,000
Lease Liability (note d) 3,000,000 5,000,000
Total Liabilities =P 6,216,000

Audit notes:
a. The purchases journal included the following transactions several days before and after
December 31, 2018 December Purchase Journal:
Purchase Invoice Receiving Report Amount Terms
Date Number/Date
Dec. 26, 2018 1012/Dec. 30, 2018 =P 50,000 FOB Destination
Dec. 28, 2018 1014/Jan. 2, 2018 =P 40,000 FOB Shipping Point
Dec. 30, 2018 1015/ Jan. 2, 2019 =P 35,000 FOB Destination
Dec. 30, 2018 1017/ Jan. 4, 2019 =P 25,000 FOB Shipping Point

January Purchase Journal:

Purchase Invoice Receiving Report Amount Terms
Date Number/Date
Dec. 29, 2018 1013/Dec. 30, 2018 =P 65,000 FOB Destination

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 Dec. 29, 2018 1016/Jan. 3, 2019 =P 40,000 FOB Shipping Point
January 2, 2019 1018/ Jan. 5, 2019 =P 30,000 FOB Shipping Point

b.The premiums payable balance was the accrued amount in December 31, 2017 for a promotional program the company has started in
2017. For every 5 product labels the customer surrenders plus =P 50, the customer receives a specially designed wall clock which the
company purchases at a cost =P 160/unit. Details about the said promotional program in 2017 and 2018 are as follows:
2017 2018
Sales in units 50,000 60,000
Premiums purchased in units 3,000 6,000
Inventory of premiums at the end of each
year 1,200 2,100

The company estimates that from the labels issued with products sold, 40% shall be presented for the said promotional plan
redemption.

c. The 10% convertible bonds payable maturing on December 31, 2019, were issued on January 1, 2017 at =P 2,050,000. The prevailing
market rate of interest for similar securities at that time without conversion option was at 12%. The issuance was recorded as a debit to
cash for the proceeds and credit to bonds payable at face value with the difference being charged to interest expense. The bonds were
convertible to ordinary shares (=P 1,000 bonds to 10, =P 50 par value ordinary shares). Interest are payable on the bonds annually every
December 31. On December 31, 2018 after the payment of the annual interest which was recorded appropriately, half of the bonds were
converted to ordinary shares. The conversion is yet to be recorded by JUANITO DESPACITO Inc.

d.The lease liability is for a five-year lease agreement for an equipment of PAQUITO Corp. on January 1, 2018: The equipment which had a
useful life of 10 years had a fair market value on January 1, 2018 at =P 2,400,000. There is no provision to transfer ownership to JUANITO
DESPACITO Inc. nor is there an agreement for a bargain purchase option at the end of the lease term. The lease agreement requires
PAQUITO DESPACITO Inc. to pay =P 600,000 annually starting December 31, 2018. The implicit lease rate know to both parties was at
8% while the incremental borrowing rate was at 10%. The lease was recorded by the company as a debit to equipment and a credit to
lease liability at =P 3,000,000 (the total payments to be made for the lease.). The company is yet to record the first lease payment made
on December 31, 2018.

Answer the following questions:

1. What is the correct accounts payable as of December 31, 2018?

2. What is the correct premiums payable as of December 31, 2018?
3. What is the correct interest expense in 2018 on the bonds payable?
4. What is the credit to shareholder’s equity as a result of the conversion of half of the bonds on December 31, 2018?
5. What is the correct carrying value of the lease liability as of December 31, 2018?