AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2

AUDIT OF LIABILITIES

MULTIPLE CHOICE: Select the best answer from the choices provided. Sources: AICPA/RPCPA/Various
Test banks.

PROBLEM 1
In connection with your audit of Aladdin Corporation, you gathered the following liability and equity
account balances as of December 31, 2025:

11% bonds payable (at face value) P 20,000,000

Premium on bonds payable 1,409,520
Ordinary shares 32,000,000
Share premium 9,180,000
Accumulated profits 9,860,000
Treasury shares 1,300,000

Transactions during 2026 and other information relating to the Corporation’s liability and equity accounts
were as follows:
a. The bonds were issued on December 31, 2023, for P 21,512,000 to yield 10%. The bonds mature
on December 31, 2028. Interest is payable annually on December 31. The corporation uses the
effective interest method to amortize bond premium.
b. At December 31, 2025, the Corporation had 8,000,000 authorized ordinary shares of P 10 par per
share.
c. On January 15, 2026, the Corporation reissued 60,000 of its 100,000 treasury shares for P
1,100,000. The treasury shares had been acquired on February 28, 2025.
d. On November 2, 2026, the Corporation borrowed P 16,000,000 at 9% evidenced by a note payable
to ABC Bank. The note is payable in five equal annual principal installments of P 3,200,000. The
first principal and interest payment is due on November 2, 2027.

Required: Based on the above and the result of your audit, determine for the following:

1. Carrying value of the bonds payable at December 31, 2026.

a. 21,350,472 c. 18,649,528
b. 21,409,520 d. 21,308,720

2. Treasury shares balance at December 31, 2026.

a. 400,000 c. 520,000
b. 1,100,000 d. 200,000

3. Noncurrent portion of the note payable to bank as of December 31, 2026.

a. 12,800,000 c. 16,000,000
b. 3,200,000 d. Principal and Interest are both current

4. 2026 total interest expense

a. 2,440,000 c. 2,499,048
b. 2,380,952 d. 2,374,472
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AUDIT OF LIABILITIES

PROBLEM 2
On January 1, 2017, Tadano Co. issued eight-year bonds with a face value of P1,000,000 and a stated
interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield
8%. Table values are:
Present value of 1 for 8 periods at 6% ......................................... .627
Present value of 1 for 8 periods at 8% ......................................... .540
Present value of 1 for 16 periods at 3% ....................................... .623
Present value of 1 for 16 periods at 4% ....................................... .534
Present value of annuity for 8 periods at 6%................................ 6.210
Present value of annuity for 8 periods at 8%................................ 5.747
Present value of annuity for 16 periods at 3%.............................. 12.561
Present value of annuity for 16 periods at 4%.............................. 11.652
1. The present value of the principal is
a. P534,000.
b. P540,000.
c. P623,000.
d. P627,000.
2. The present value of the interest is
a. P344,820.
b. P349,560.
c. P372,600.
d. P376,830.
3. The issue price of the bonds is
a. P883,560.
b. P884,820.
c. P889,560.
d. P999,600.
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

PROBLEM 3
An entity provided the following pension plan information:

Projected benefit obligation – January 1 3,500,000

Fair value of plan assets – January 1 2,800,000
Pension benefits paid during the year 250,000
Current service cost for the year 1,750,000
Past service cost for the year (vesting period 5 years) 425,000
Actual return on plan assets 180,000
Contribution to the plan 1,500,000
Actuarial loss due to change in assumptions on projected benefit obligation 200,000
Discount or settlement rate 10%

1. What is the employee benefit expense for the current year?

a. 2,245,000
b. 1,905,000
c. 2,525,000
d. 1,750,000

2. What is the net remeasurement loss for the current year?

a. 200,000
b. 100,000
c. 300,000
d. 400,000

3. What is the projected benefit obligation on December 31?

a. 5,550,000
b. 5,075,000
c. 5,775,000
d. 5,975,000

4. What is the fair value of plan assets on December 31?

a. 4,480,000
b. 4,230,000
c. 4,300,000
d. 4,050,000

5. What amount should be reported as accrued benefit cost on December 31?

a. 1,745,000
b. 1,750,000
c. 1,045,000
d. 700,000
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

PROBLEM 4
WALANGKADATESA214, Inc. 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
WALANGKADATESA214, Inc. has signed several long-term 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 600,000
July 31, 2020 900,000
September 1, 2020 450,000
February 1, 2021 450,000
April 1, 2006 – March 31, 2022 2,700,000

Estimated warranties
WALANGKADATESA214, Inc. 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, WALANGKADATESA214, Inc.’s board of directors declared a cash dividend of P0.30
per common share and a 10% common stock dividend. Both dividends were to be distributed on April 5,
2020 to common stockholders on record at the close of business on March 31, 2020. As of March 31,
2020, WALANGKADATESA214, Inc. has 5 million, P2 par value, common shares issued and outstanding.

Bonds payable
WALANGKADATESA214, Inc. 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.
WALANGKADATESA214, Inc. uses the straight line method to amortize bond discount.
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AUDIT OF LIABILITIES

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

1. Estimated warranty liability

a. P252,000
b. P345,000
c. P630,000
d. P882,000

2. Unamortized bond discount

a. P110,000
b. P200,000
c. P100,000
d. P90,000

3. Bond interest payable

a. P0
b. P300,000
c. P150,000
d. P250,000

4. Total current liabilities

a. P6,445,000
b. P5,105,000
c. P5,445,000
d. P3,945,000

5. Common stock
a. P7,700,000
b. P7,590,000
c. P7,500,000
d. P7,610,000
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

PROBLEM 5
You are auditing the financial statements of PRIA Inc. for the year ended December 31, 20x4. The liability
portion of the company’s balance sheet shows the following information:
Current Liabilities
Accounts payable P250,000
Warranties liability 10,000 P260,000
Noncurrent Liabilities
Liability under finance lease P540,000
Bonds payable 851,706 P1,391,706
Upon further investigation on the liabilities account, you discovered the following information:

A Accounts payable:
You rendered purchases cutoff on the company's purchases transactions from December 15 to January
15. The results of such cut-off are summarized below:
Receiving Amount Invoice Date Shipment Shipment
Report No. Date Terms
2631 P5,500 12/15/20x4 12/15/20x4 FOB Supplier
2632 6,000 12/17/20x4 12/20/20x4 FOB Supplier
2633 7,900 12/21/20x4 12/21/20x4 FOB Buyer
2635 8,900 12/26/20x4 12/30/20x4 FOB Buyer
2636 10,000 12/30/20x4 12/30/20x4 FOB Supplier
2637 8,000 12/30/20x4 1/2/20x5 FOB Supplier
2638 9,500 12/31/20x4 12/31/20x4 FOB Buyer
2639 10,500 1/2/20x5 1/5/20x5 FOB Buyer
2640 11,000 1/5/20x5 1/10/20x5 FOB Supplier
2641 12,000 1/7/20x5 1/11/20x5 FOB Supplier
2642 P15,000 1/10/20x5 1/15/20x5 FOB Buyer

The inventory count procedures were done in December 31, 20x4 and documents cut-off shows that
the last receiving report used and recorded for the current year by the company is RR number 2635.

Receiving report number 2634 is for a shipment made on December 27, 20x4. The related invoice
amounting to P12,500, was misplaced and was recovered only on January 5, 20x5 and was recorded
thereafter.

B Warranty Liability:
The company/has a two-year warranty on its products. The warranty estimates in the past years were
at 5% of the net sales. During the current year because of increased returns the company decided to
increase warranty estimates at 6% of its total net sales, two thirds of which is expected to be incurred
during the year of sale and one-third on the year following the year of sale. The summary of the
company's total sales and actual warranty costs incurred for the past three years are presented below
(Assume sales were made evenly throughout the year):
20x2 20x3 20x4
Net Sales P8,000,000 9,050,000 10,550,000
Actual warranty costs paid 375,000 467,500 310,000

The company is yet to update its warranty liabilities as of December 31, 20x4.
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

C Other Accruals:
You also conducted a search for unrecorded liabilities by reviewing the voucher register several days
before and after the balance sheet date. Your review is summarized below:

Entry date Voucher Description Amount Account Charged

Reference
Dec. 18, 20x4 12 - 200Supplies, shipped FOB
destination, received
12/17/20x4 P1,500 Unused supplies
Dec. 18, 20x4 12 - 203 Auto insurance,
12/15/20x4 to
12/15/20x5 20,000 Prepaid insurance
Dec. 26, 20x4 12 - 212 Repairs services; Repairs and
Received 12/20 1,900 maintenance
Dec. 28, 20x4 12 - 215 Utilities for December 2,400 Utilities expense
Jan. 3, 20x5 1-1 Legal services; Legal and
Received 12/28/20x4 4,600 professional fees
Jan. 4, 20x5 1 - 2 Medical services for
employees in 20x4 5,500 Medical expense
Jan. 10, 20x5 1 - 3 Payroll 12/21/20x4 to
1/5/20x5 (12 working Salaries and
days, 4 days in Jan.) 14,400 wages
Jan. 12, 20x5 1 - 4Royalties in December
3,900 Royalty expense
Jan. 14, 20x5 1-5 Repairs services; Repairs and
received on 1/9/20x5 1,900 maintenance

D Liability Under Finance Lease:

The company leases one of its warehouse from Princesa Properties Inc. The terms of the lease provide
for minimum lease payments ofP250,00&, per semi-annual period, payable every June 30 and
December 31. The initial lease term runs for ten years with no renewal or purchase options. The
company is responsible for paying property taxes and also for needed repairs to the warehouse. The
cost of the warehouse to Princesa Properties was at P3,000,000 and the market value at the date of
completion was P3,397,582. The explicit interest rate stated in the lease agreement is 8%. The lease
was signed and the warehouse occupied on January 2, 20x4.

The company recorded the lease liability at the total amount expected to be paid for the 10-year period,
and charges the same for the semi-annual payments made.

E Bonds Payable:
The company issued P800,000 of 12% face value bonds for P851,706, The bonds were dated and
issued on April 1, 20x4, are due March 31, 2018, and pay interest semiannually on September 30 and
March 31. The company sold the bonds to yield 10%

1. What is the correct balance of the accounts payable account?

a. 272,500 c. 290,000
b. 282,000 d. 260,000
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

2. What is the correct balance of the warranties liability?

a. 308,000 c. 323,000
b. 318,000 d. 333,000

3. How much is the correct additional accruals to be included in the company's total current liabilities?
a. 47,600 c. 23,600
b. 28,400 d. 25,500

4. What is balance of the liability under finance lease to be presented as long-term liabilities?
a. 2,913,074 c. 3,164,824
b. 3,823,326 d. 3,520,251

5. How much is carrying value of the bonds payable as of December 31, 20x4?
a. 843,448 c. 843,584
b. 840,606 d. 840,817

PROBLEM 6
In connection with the audit of the company’s financial statements for the year ended December 31, 20x6 the
PRIA Corporation presented to you their records. This is the first time the company has been audited. The
company issued serial bonds on April 1, 20x3. Your audit showed the following details of the issue and the
accounts as of December 31, 20x6:

Total face value P2,000,000

Date of bond March 1, 20x2
Total proceeds P2,656,000
Interest rate 12% per annum
Interest payment date March 1
Maturity dates and amount:

Date of maturity Amount

March 1, 20x6 P 500,000
March 1, 2007 500,000
March 1, 20x8 500,000
March 1, 2009 500,000
P2,000,000

Since the corporation had excess cash, bonds of P500,000 scheduled to be retired on March 1, 20x8 were
retired on April 1, 20x6. The total amount paid was charged to serial bonds payable account.

Serial Bonds Payable

3/01/20x6 VR P500,000 4/01/20x3 CR P2,656,000
4/01/20x6 VR P495,000
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

Accrued Interest Payable

01/01/20x6 GJ P200,000

Interest Expense
3/01/20x6 VR P240,000

Required
Based on the information presented above and the result of your audit, answer the following: (Use bond
outstanding method to amortize premium or discount)
1. The adjusted balance of the bonds payable account as of December 31, 20x6 is
2. The unamortized bond premium as of December 31, 20x6 should be
3. The accrued interest payable as of December 31, 20x6 is
4. The bond interest expense that should be reported by the corporation for the year 20x6 is
5. The gain on early retirement of bonds is

PROBLEM 7
PRIA Inc. had the following unadjusted liability balances as of December 31, 20x4:
Accounts payable P540,000
Premiums payable 440,000
Deferred taxes (42,000)
10% Bonds payable 5,500,000

Audit notes:
A Accounts payable is net of a P50,000 debit9balance in one of the company's suppliers accounts due
to an overpayment made. The agreement with the supplier simply calls for the supplier to deliver
additional merchandise to PRIA Inc. to offset the overpayment. No deliveries were made as of the
balance sheet date.
B The company started a promotional program in 20x3 where an eco-friendly tote bag shall be given to
customers upon presenting 6 product labels plus P5 cash. The following information are deemed
relevant in relation to the program:
20x3 20x4
Sales P7,200,000 P8,400,000
Total cost of tote bags purchased 375,000 500,000
(P25 per tote bag)
Tote bags actually distributed 9,000 19,000
Estimated tote bags to be distributed the following
year 7,000 5,000
The balance of the premiums liability account, reflects the accrual at the end of the previous year (20x3),
no entry had been made during the current year affecting the said account.
C Deferred tax balance appearing above is the result of the deferred tax created by the premiums liability
in the previous year which is tax deductible upon settlement. Adjustments are yet to be made to the
said account to reflect the movement in the account balance during the year. Moreover, another
temporary difference arising during the year created by the company's excess tax depreciation over
financial depreciation for the period amounted to P150,000. The income tax rate is at 30%.
D The balance of the bonds payable account was the total proceeds from its issuance on January 1,
20x4. The bonds which shall mature on December 31, 2018 have a total face value of P5,000,000 and
are convertible into ordinary shares at the rate of P1,000 bond to 10, P50 par value ordinary shares.
On the issuance date the effective yield rate on similar securities without the convertibility option was
at 8% while each ordinary shares were selling at P75 per share. The only other entry made by the client
in relation to the bonds was the payment of interest on December 31, as interest are payable annually
every December 31.
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

Required
1. What is the correct premiums expense for 20x4?
a. 320,000 c. 380,000
b. 480,000 d. 340,000

2. What is the total deferred tax liability as of December 31, 20x4?

a. 30,000 c. 45,000
b. 15,000 d. 75,000

3. What is the total current liability to be reported in the 20x4 statement of financial position?
a. 735,000 c. 890,000
b. 590,000 d. 690,000

4. What is the correct credit to shareholders' equity account as a result of the issuance of the bonds on
January, 20x4?
a. 100,729 c. 168,787
b. 399,271 d. 500,000

5. Assuming that the bonds were converted on January 2, 2016, what is the total credit to share premium
as a result of the conversion?
a. 2,761,439 c. 2,931,213
b. 2,831,213 d. 2,858,439

6. Assuming that the bonds were retired on January 2, 2016, at 105, when the prevailing market rate of
interest for similar securities without conversion option is at 12%, how much should be reported in the
profit or loss as a result of the retirement?
a. 571,396 c. 639,454
b. 297,893 d. 479,893

PROBLEM 8
Determine the implication of the following independent cases to the December 31, 20x4 financial
statements as per PAS 37, Provisions, Contingent Liabilities, and Contingent Assets.

Case 1:
On December 5, 20x4, an employee filed a P3,000,000 lawsuit against FS Company for damages suffered
when one of FS' equipment malfunctioned in August of 20x4. In your inquiry of FS Company's legal counsel,
the legal counsel expects the company will lose the lawsuit and estimates the loss to be between P500,000
and P1,500,000. The employee has offered to settle the lawsuit out of court for P1,200,000, but FS
Company will not agree to the settlement.

Case 2:
FS Company guaranteed a loan of P2,000,000 of one of its key officers from a bank in 20x4. By the time
the financial statement of FS company were approved for issuance by the its BOD, it is clear that the key
officer is in financial difficulties and it is probable that FS company will meet the guarantee.

Case 3:
On December 20, 20x4, an explosion occurred at FS Company's plant causing extensive property damages
to adjacent areas. Although no claims had yet been asserted against FS Company by April 15, 20x5, FS
Company's management and counsel believes that it is probable that the company will be liable for
damages, and that P2.5M would be reasonable estimate of its liability. The legal counsel further opines that
the total liability may possibly be up to P5M given the extent of the damages to the neighboring areas. FS
Company's P10M comprehensive public liability policy has a P1M deductible clause.
 AUDITING AND ASSURANCE CONCEPTS AND APPLICATION 2
AUDIT OF LIABILITIES

Case 4:
On January 12, 20x5, a fire at the production area of FS company damaged a number of adjacent buildings.
FS Company's insurance policy does not cover damages to property of others. The adjacent neighbors
have filed a P2M damages suit against the company and the legal counsel opines that it is probable that
such damages will be awarded to them.

1. Case 1
a. Accrue liability at P1,200,000 c. Accrue liability at P1,000,000
b. Accrue liability at P1,000,000 d. Accrue liability at P1,000,000

2. Case 2
a. Disclose contingency at P2,000,000 c. Accrue liability at P2,000,000
b. Disclose contingency at P2,000,000 d. Accrue liability at P2,000,000

3. Case 3
a. Accrue liability at P1,500,000 c. Accrue liability at P1,000,000
b. Accrue liability at P1,000,000 d. Accrue liability at P1,500,000

4. Case 4
a. Accrue liability at P2,000,000 c. Disclose contingency at P2,000,000
b. Disclose contingency at P2,000,000 d. Accrue liability at P2,000,000

PROBLEM 9
You were engaged to audit the December 31, 20x4, financial statements of PRIA Company, a manufacturer
of household appliances. Your audit disclosed the following findings:

1 In June 20x4, the company began producing and selling a new line of washing machines. By the end
of the year, it has sold 30,000 units to various dealers for P30,000 each. The product was sold under
a one-year warranty. The company estimates warranty costs to be P1,200 in labor and P300 in parts
per washing machine. Industry experience indicate that 60% of the units sold will ultimately be returned
for repairs during the warranty period. PRIA Company incurred total warranty costs at P19.5M as of
December 31, 20x4 which is also the amount shown as warranty expense in its statement of
comprehensive income.

2 In response to your letter of audit inquiry, PRIA Company's lawyers informed you that the company is
involved in a lawsuit for violating environmental laws regulating hazardous waste. Although the litigation
is still pending, PRIA Company's lawyers is certain that PRIA Company wilt most probably have to pay
cleanup cost and fines of P2,000,000. PRIA Company neither accrued nor disclosed this loss in the
financial statements. On April 1, 20x5, before the 20x4 financial statements were approved for
issuance, the court has finalized its decision penalizing the company a total of P2,600,000 in cleanup
costs and fines.

3 On January 1, 20x2, PRIA Company entered into an 6-year lease agreement for a building hich it has
been using as a warehouse. The building which has a useful life of 10 years shall be reverted back to
the lessor after the lease expires. The annual lease payment amounting to P800,000 paid at the
beginning of each year had been charged by the company to annual rental expense. Your audit
investigation revealed however that on January 1, 20x2, the leased building has a fair market value of
P4,000,000. You also discovered that on January 1, 20x2, the implicit lease rate known to PRIA
Company was at 12% while the incremental borrowing rate was at 10%.
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AUDIT OF LIABILITIES

4 On January 1, 20x4, PRIA Company issued a 3-year, P4,000,000, 10% bonds at P4,250,000. The
bonds are convertible to 50,000 ordinary shares (P50 par value) at any time up to maturity. Interest on
the bonds are payable semi-annually every June 30 and December 31. Similar securities without
conversion option had prevailing market rate of interest at 12%. The issuance was recorded as a debit
to cash and credit to bonds payable for the total cash proceeds. Semi-annual interest payments were
appropriately recorded. On December 31, 20x4, P3,000,000 of the bonds were converted to ordinary
shares. No entry had been made by the company upon the said conversion.

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

1. What is the correct provision for warranties as of December 31, 20x4?

a. 2,100,000 c. 9,500,000
b. 7,500,000 d. 13,500,000

2. What is the correct provision from environmental damages should the company accrue as of
December 31, 20x4?
a. none c. 2,300,000
b. 2,000,000 d. 2,600,000

3. What is the correct carrying value of any lease liability as of December 31, 20x4?
a. none c. 2,475,983
b. 1,921,465 d. 1,352,041

PROBLEM 10

1. A client's purchasing system ends with the assumption of a liability and the eventual payment of the
liability. Which of the following best describes the auditor's primary concern with respect to liabilities
resulting from the purchasing system?
a. Commitments for all purchases are made only after established competitive bidding procedures
are followed.
b. Accounts payable are not materially understated.
c. Authority to incur liabilities is restricted to one designated person.
d. Acquisition of materials is not made from one vendor or one group of vendors.

2. Which of the following functions is not appropriate for the accounts payable department?
a. Prepare purchase orders.
b. Prepare voucher and daily summary.
c. File voucher package by due date.
d. Compare purchase requisitions, purchase orders, receiving reports, and vendors' invoices.

3. In a properly designed accounts payable system, a voucher is prepared after the invoice, purchase
order, requisition, and receiving report are verified. The next step in the system is to
a. Post the voucher amount to the expense ledger.
b. Cancel the supporting documents.
c. Enter the check amount in the check register.
d. Approve the voucher for payment.
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AUDIT OF LIABILITIES

4. Which of the following would be the best procedure to determine whether purchases were properly
authorized?
a. Discuss authorization procedures with personnel in the controller's and purchasing functions.
b. Review and evaluate a flowchart of purchasing procedures.
c. Determine whether a sample of entries in the purchase journal is supported by properly executed
purchase orders.
d. Vouch payments for selected purchases to supporting receiving reports.

5. In conducting a search for unrecorded liabilities, the auditor should do all but the following:
a. Examine prior year's audit workpapers to ascertain that adjustments for unrecorded liabilities have
not been overlooked.
b. Examine invoices paid a few days prior to the balance sheet date.
c. Examine paid invoices for a short period following the balance sheet date and trace to client's year-
end adjustment for unrecorded liabilities.
d. Examine unpaid invoices for a short period following the balance sheet date and trace to client's
year-end adjustment for unrecorded liabilities.