AUDITING AND ASSURANCE CONCEPTS AND APPLICATIONS 1

Module 5.1_Audit of Property, Plant and Equipment

INTERNAL CONTROL MEASURES

1. Additions and dispositions of fixed assets should be properly authorized and approved by the board of directors or
executive committee or person to whom authority has been delegated.

2. A clearly defined and sound policy for differentiation of capital and revenue expenditures should be established.

3. Cost of constructed fixed assets should be controlled through work orders.

4. Fixed assets controlling account should be supported by detailed plant records.

5. Physical inspection of fixed assets should be conducted and investigated.

SUBSTANTIVE AUDIT OF PROPERTY, PLANT AND EQUIPMENT

Existence: Recorded property, plant and equipment exist Rights and obligations: Property, plant and equipment are
owned by the entity
1. Physically inspect the assets for a sample of property,
plant and equipment recorded in the plant ledger. 7. Determine whether liens or mortgages have been
placed on property, plant and equipment by examining
2. Physically inspect the assets and examine supporting bank confirmations and reading minutes of the board
documentation for additions to property, plant and of directors’ meetings.
equipment.
Valuation and allocation: Property, plant and equipment
3. Verify that existing retirements and disposals are are valued in accordance with GAAP
recorded and properly valued.
8. Verify accuracy of recorded property, plant and
equipment.
Completeness: All property, plant and equipment are
recorded 9. Verify depreciation.

4. Perform analytical procedures.

Presentation and disclosure: Property, plant and
5. Analyze repairs and maintenance for expenditures that equipment are classified and disclosed in accordance with
should have been capitalized. GAAP

6. Examine lease and loan agreements to identify any 10. Review financial statements and perform analytical
liabilities that should be recorded. procedures to determine whether accounts are
classified and disclosed in the financial statements in
accordance with GAAP.

- end -

PROBLEM NO. 1 shares (par value = P100/share) which is very actively

traded and had a market value per share of P210.
Black Manufacturing Co. was incorporated on 1/2/17 but
was unable to begin manufacturing activities until 8/1/17
2. When the old building was removed, Black paid Kwik
because new factory facilities were not completed until
Demolition Co. P5,000, but also received P2,000 from
that date. The Land and Building account at 12/31/17 per
the sale of salvaged material. The amount received
the books was as follows:
was credited to other income.
Date Particulars Amount
3. Legal fees covered the following:
1/31/17 Land and dilapidated building P200,000
2/28/17 Cost of removing building 5,000 Cost of organization P2,000
4/1/17 Legal fees 6,000 Examination of title covering purchase of
5/1/17 Fire insurance premium payment 7,200 land 2,500
5/1/17 Special tax assessment for streets 5,500 Legal work in connection with the building
5/1/17 Partial payment of new building construction 1,500
construction 180,000 P6,000
8/1/17 Final payment on building 4. The fire insurance premium covered premiums for a
construction 180,000 three-year term beginning May 1, 2017.
8/1/17 General expenses 30,000
12/31/17 Asset write-up 75,000 5. General expenses covered the following for the period
P688,700 1/2/17 to 8/1/17.

Additional information: President's salary P20,000

Plant superintendent covering supervision
1. To acquire the land and building on 1/31/17, the
of new building 10,000
company paid P100,000 cash and 1,000 ordinary
P30,000

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 2. Determine the proper balances as of 12/31/17 for a
6. Because of the rising land costs, the president was separate land account and a separate building account.
sure that the land was worth at least P75,000 more
than what it cost the company. The company credited
retained earnings account.

REQUIRED:
1. Prepare the necessary adjusting journal entries to
close the Land and Building account and to set up the
appropriate accounts.

PROBLEM NO. 2
You were engaged in making your second annual examination of Indigo Company. The Machinery and Accumulated
Depreciation accounts are shown below:
Machinery
01/01/17 Balance P 500,000 09/01/17 Sale of machine
No. 3 P 10,000
06/01/17 Machine No. 23 150,000 12/31/17 Balance 644,000
09/01/17 Dismantling of
Machine No. 3 4,000 .
P 654,000 P 654,000
01/01/18 Balance P 644,000

Accumulated Depreciation
12/31/17 Balance P 344,400 01/01/17 Balance P 280,000
. 12/31/17 Depreciation 64,400
P 344,400 P 344,400
01/01/18 Balance P 344,400

Your examination disclosed the following information: b. P301,458 d. P340,500

a. The company has depreciated all items of machinery at 5. The adjusting entry to correct the entry made in
10% per annum. The oldest item owned is seven recording sale of Machine no. 3 will include a debit to
years old as of December 31, 2017. a. Loss on sale of machinery P42,000
b. Accumulated depreciation P32,000
b. The following adjusted balances appeared on
c. Both a and b
December 31, 2016 working papers:
d. No adjusting entry is necessary.
Machinery – P500,000; Accumulated Depreciation –
P 280,000.
PROBLEM NO. 3
c. Machine No. 3, which was purchased on March 1,
In the audit of the books of Yellow Company for the year
2013, at a cost of P80,000, was sold on September 1,
2017, the following items and information appeared in the
2017 for P10,000 cash.
Production Machines account of the auditee:
d. Included in charges to Repairs and Maintenance
Date Particulars Debit Credit
account was an invoice for installation of Machine No.
2017
23, in the amount of P35,000.
01/01 Balance–Machines 1,
e. It is the company’s policy to take full year’s 2, 3, and 4 at
depreciation in the year of acquisition and none in the P90,000 each P 360,000
year of disposition. 08/31 Machine 5 198,000
Machine 1 P 3,000
QUESTIONS: 09/30 Machine 6 96,000
12/01 Machines 7 and 8 at
Based on the information presented above and the result P216,000 each 432,000
of your audit, answer the following: 12/01 Machine 2 21,000
1. How much is the loss on the sale of Machine no. 3? 12/31 Balance . 1,062,000
a. P38,000 c. P42,000 P1,086,000 P1,086,000
b. P37,333 d. P 0
The Accumulated Depreciation account contained no
2. How much is the adjusted balance of the Machinery entries for the year 2017. The balance on January 1, 2017
account as of December 31, 2017? per your audit, was as follows:
a. P644,000 c. P605,000
b. P296,500 d. P609,000 Machine 1 P 84,375
Machine 2 39,375
3. How much is the total depreciation expense on Machine 3 33,750
machinery for 2017? Machine 4 22,500
a. P64,400 c. P50,000 Total P 180,000
b. P60,500 d. P58,125
4. How much is the balance of the Accumulated Based on your further inquiry and verification, you noted
Depreciation account as of December 31, 2017? the following:
a. P308,500 c. P344,000

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1. Machine 5 was purchased for cash; it replaced Machine amount to Semitrucks account. (Assume
1, which was sold on this date for P3,000. truck No. 2 was not retired.)

2. Machine 2 was destroyed by the thickness of engine oil July 1, 2016 Truck No. 4 was damaged in a wreck to
used leading to explosion on December 1, 2017. such an extent that it was sold as junk for
Insurance of P21,000 was recovered. Machine 7 was P7,000 cash. Blue Mfg. Co. received
to replace Machine 2. P25,000 from the insurance company. The
entry made by the bookkeeper was a debit
3. Machine 3 was traded in for Machine 6 at an allowance to cash, P32,000, and credits to
of P12,000; the difference was paid in cash and Miscellaneous Income, P7,000 and
charged to Production Machine account. Semitrucks P 25,000.

4. Depreciation rate is recognized at 25% per annum. Entries for depreciation had been made for the close of
each year as follows: 2014, P203,000; 2015, P211,000;
REQUIRED: 2016, P244,500; 2017, P278,000.

Determine the adjusted balance of the Production Machine QUESTIONS:

as of December 31, 2017 and Depreciation Expense for the
year 2017. Based on the above and the result of your audit, determine
the following: (Disregard tax implications)
SOLUTION GUIDE:
1. The carrying amount of Semitrucks as of December 31,
Adj. Bal., 2017 2017 is
No Remarks 12/31/17 DA Fraction Dep. a. P885,400 c. P284,000
1 b. P504,000 d. P354,000
2 2. The 2017 depreciation expense is
3 a. P138,000 c. P184,000
4 b. P104,000 d. P140,000
5
6 3. The 2014 profit is overstated by
7 a. P9,000 c. P20,000
b. P31,000 d. P 0
8
4. The 2015 profit is understated by
a. P16,000 c. P51,000
b. P50,000 d. P 0
PROBLEM NO. 4
5. The 2016 profit is understated by
You requested a depreciation schedule for Semitrucks of a. P23,500 c. P94,500
Blue Manufacturing Company showing the additions, b. P64,500 d. P 0
retirements, depreciation and other data affecting the
income of the Company in the 4-year period 2014 to 2017,
inclusive. The Semitrucks account consists of the following SOLUTION GUIDE (Questions 1 & 2):
as of January 1, 2014:
12/31/17
Truck No. 1 purchased Jan. 1, 2018, cost P 180,000 No Remarks Cost Acc. Dep. 2017 Dep.
Truck No. 2 purchased July 1, 2018, cost 220,000 1
Truck No. 3 purchased Jan. 1, 2013, cost 300,000 2
Truck No. 4 purchased July 1, 2013, cost 240,000 3
P 940,000 4
5
The Semitrucks – Accumulated Depreciation account
6
previously adjusted to January 1, 2014, and duly entered
to the ledger, had a balance on that date of P302,000
(depreciation on the 4 trucks from respective date of
SOLUTION GUIDE (Questions 3 to 5):
purchase, based on five-year life, no salvage value). No
charges have been made against the account before Depreciation
January 1, 2014. No Remarks 2014 2015 2016
1
Transactions between January 1, 2014 and December 31, 2
2017, and their record in the ledger were as follows: 3
July 1, 2014 Truck No. 3 was traded for larger one (No. 4
5), the agreed purchase price of which was 5
P340,000. Blue Mfg. Co. paid the 6
automobile dealer P150,000 cash on the
transaction. The entry was debit to
Semitrucks and a credit to cash, P150,000. PROBLEM NO. 5

Jan. 1, 2015 Truck No. 1 was sold for P35,000 cash; Select the best answer for each of the following:
entry debited Cash and credited 1. Property, plant and equipment is typically judged to be
Semitrucks, P35,000. one of the accounts least susceptible to fraud because
a. The amounts recorded on the balance sheet for
July 1, 2016 A new truck (No. 6) was acquired for most companies are immaterial.
P360,000 cash and was charged at that b. The inherent risk is usually low.

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 c. The depreciated values are always smaller than
cost.
d. Internal control is inherently effective regarding
this account.
2. Determining that proper amounts of depreciation are
expensed provides assurance about management’s
assertions of valuation and
a. Presentation and disclosure.
b. Rights and obligations.
c. Completeness.
d. Existence or occurrence.
3. The auditor may conclude that depreciation charges
are insufficient by noting
a. Insured values greatly in excess of book values.
b. Large numbers of fully depreciated assets.
c. Continuous trade-in of relatively new assets.
d. Excessive recurring losses on assets retired.
4. When few property and equipment transactions occur
during the year the continuing auditor usually obtains
and understanding of internal control and performs
a. Tests of controls
b. Analytical procedures to verify current year
additions to property and equipment
c. A thorough examination of the balances at the
beginning of the year.
d. Extensive tests of current year property and
equipment transactions.
5. Which of the following combinations of procedures is
an auditor most likely to perform to obtain evidence
about fixed asset addition?
a. Inspecting documents and physically examining
assets.
b. Recomputing calculations and obtaining written
management representations.
c. Observing operating activities and comparing
balances to prior period balances.
d. Confirming ownership and corroborating
transactions through inquiries of client personnel.
6. If an auditor tours a production facility, which of the
misstatements or questionable practices is most likely
to be detected by the audit procedures specified?
a. Depreciation expense on fully depreciated
machinery has been recognized.
b. Overhead has been overapplied.
c. Necessary facility maintenance has not been
performed.
d. Insurance coverage on the facility has lapsed.
7. In testing for unrecorded retirements of equipment, an
auditor is most likely to
a. Select items of equipment from the accounting
records and then locate them during the plant
tour.
b. Compare depreciation journal entries with similar
prior-year entries in search of fully depreciated
equipment.
c. Inspect items of equipment observed during the
plant tour and then trace them to the equipment
subsidiary ledger.
d. Scan the general journal for unusual equipment
additions and excessive debits to repairs and
maintenance expense.
8. An auditor analyzes repairs and maintenance accounts
primarily to obtain evidence in support of the audit
assertion that all
a. Noncapitalizable expenditures for repairs and
maintenance have been recorded in the proper
period.
b. Expenditures for property and equipment have
been recorded in the proper period.
c. Noncapitalizable expenditures for repairs and
maintenance have been properly charged to
expense.
d. Expenditures for property and equipment have not
been charged expense.
9. In violation of company policy, Coatsen Company
erroneously capitalized the cost of painting its
warehouse. An auditor would most likely detect this
when
a. Discussing capitalization policies with Coatsen's
controller.
b. Examining maintenance expense accounts.
c. Observing that the warehouse had been painted.
d. Examining construction work orders that support
items capitalized during the year.
- now answer your Self-test drill (STD) -

Self-Test DRILL (STD)

Instruction: Answer the following problems. Submit answers through the google form to be uploaded in
Big Sky as your Performance Assessment 3. Submit on or before the date and time indicated in the
drop box to be designated for the purpose of submission. Late submission will not be entertained. Each
Problem is worth 10 points.
PROBLEM NO. 1 collision 35,000
09/01/16 Insurance
The following information pertain to Teal Company’s
recovery on Truck
delivery trucks:
4 accident P33,000
DELIVERY EQUIPMENT 10/01/16 Sale of Truck 2 600,000
Date Particulars Debit Credit 04/01/17 Truck 6 1,000,000 150,000
01/01/15 Trucks 1,2,3, and 05/02/17 Repainting of
4 P3,200,000 Truck 4 27,000
03/15/16 Replacement of 06/30/17 Truck 7 720,000
Truck 3 tires 25,000
07/01/16 Truck 5 800,000 ACCUMULATED DEPRECIATION-DELIVERY EQUIPMENT
07/10/16 Reconditioning of Date Particulars Debit Credit
Truck 4, which 12/31/15 Depreciation expense P300,000
was damaged in a 12/31/16 Depreciation expense 300,000

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 12/31/17 Depreciation expense 300,000 a. On January 2, 2017, Red purchased a new truck for
P500,000 cash and traded-in a 2-year-old truck with a
a. On July 1, 2016, Truck 3 was traded in for a new truck,
cost of P450,000 and a book value of P135,000. The
Truck 5, costing P850,000; the selling party allowed a
new truck has a cash price of P600,000; the market
P50,000 trade in value for the old truck.
value of the old truck is not known.
b. On April 1, 2017, Truck 6 was purchased for b. On April 1, 2017, a machine purchased for P575,000
P1,000,000; truck 1 and cash of P850,000 being given on April 1, 2012 was destroyed by fire. Red recovered
for the new truck. P387,500 from its insurance company.
c. On May 1, 2017, cost of P4,200,000 were incurred to
c. The depreciation rate is 20% by unit basis. improve leased office premises. The leasehold
d. Unit cost of trucks 1 to 4 is at P800,000 each. improvements have a useful life of 8 years. The
related lease terminates on December 31, 2016.
QUESTIONS: d. On July 1, 2017, machinery and equipment were
purchased at a total invoice cost of P7,000,000;
Based on the above and the result of your audit, answer additional cost of P125,000 for freight and P625,000
the following: for installation were incurred.
1. How much is the net loss on disposal of trucks in e. Red determined that the delivery equipment
2016? comprising the P2,875,000 balance at January 1,
a. P510,000 c. P590,000 2017, would have been depreciated at a total amount
b. P430,000 d. P230,000 of P450,000 for the year ended December 31, 2017.

2. What is the loss on trade-in of Truck 1? The salvage values of the depreciable assets are
a. P410,000 c. P250,000 immaterial. The policy of the Red Co. is to compute
b. P290,000 d. P150,000 depreciation to the nearest month.

3. What is the adjusted balance of the Delivery QUESTIONS:

Equipment account as of December 31, 2017?
a. P4,170,000 c. P3,170,000 Based on the above and the result of your audit, answer
b. P2,650,000 d. P3,370,000 the following:

4. The 2017 depreciation expense is understated by: 6. How much is the Accumulated depreciation – Buildings
a. P372,000 c. P 92,000 as of December 31, 2017?
b. P252,000 d. P292,000 a. P7,777,500 c. P8,377,500
5. Which of the following procedures would least likely b. P7,982,850 d. P7,103,700
lead the auditor to detect unrecorded fixed asset 7. How much is the Accumulated depreciation –
disposals? Machinery and Equipment as of December 31, 2017?
a. Examine insurance policies. a. P8,844,375 c. P8,614,375
b. Review repairs and maintenance expense. b. P8,830,000 d. P8,556,875
c. Review property tax files.
d. Scan invoices for fixed asset additions. 8. How much is the Accumulated depreciation – Delivery
Equipment as of December 31, 2017?
PROBLEM NO. 2 a. P2,715,000 c. P2,490,000
b. P2,400,000 d. P2,805,000
You obtain the following information pertaining to Red
Co.’s property, plant, and equipment for 2017 in 9. How much is the Accumulated depreciation –
connection with your audit of the company’s financial Leasehold Improvements as of December 31, 2017?
statements. a. P420,000 c. P525,000
b. P350,000 d. P630,000
Audited balances at December 31, 2016:
Debit Credit 10. How much is the net gain (loss) from disposal of assets
Land P3,750,000 for the year ended December 31, 2017?
Buildings 30,000,000 a. P100,000 c. P65,000
Accumulated depreciation b. (P35,000) d. (P65,000)
– buildings P6,577,500
Machinery and equipment 22,500,000 PROBLEM NO. 3
Accumulated depreciation In connection with your audit of the Gold Mining
– Machinery and Corporation for the year ended December 31, 2017, you
Equipment 6,250,000 noted that the company purchased for P16,640,000 mining
Delivery Equipment 2,875,000 property estimated to contain 12,800,000 tons of ore. The
Accumulated Depreciation residual value of the property is P1,280,000.
– Delivery Equipment 2,115,000
Depreciation Data: Building used in mine operations costs P1,280,000 and
Depreciation have estimated life of fifteen years with no residual value.
Method Useful Life Mine machinery costs P2,560,000 with an estimated
Buildings 150% declining 25 years residual value P512,000 after its physical life of 4 years.
balance
Machinery and Following is the summary of the company’s operations for
Equipment Straight-line 10 years first year of operations.
Delivery Equipment SYD 4 years Tons mined 1,280,000 tons
Leasehold Tons sold 1,024,000 tons
Improvements Straight-line - Unit selling price per ton P4.40
Direct labor 1,024,000
Transactions during 2017 and other information are as
Miscellaneous mining overhead 204,800
follows:
Operating expenses

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 (excluding depreciation) 921,600
13. How much is the Inventory as of December 31, 2017?
Inventories are valued on a first-in, first-out basis. a. P701,440 c. P680,960
Depreciation on the building is to be allocated as follows: b. P675,840 d. P669,013
20% to operating expenses, 80% to production.
14. How much is the cost of sales for the year ended
Depreciation on machinery is chargeable to production.
December 31, 2017?
a. P2,703,360 c. P2,805,760
QUESTIONS:
b. P2,723,840 d. P2,676,053
Based on the above and the result of your audit, answer
15. How much is the maximum amount that may be
the following: (Disregard tax implications)
declared as dividends at the end of the company’s first
11. How much is the depletion for 2017? year of operations?
a. P1,228,800 c. P 307,200 a. P2,391,040 c. P2,083,840
b. P1,536,000 d. P1,664,000 b. P2,063,360 d. P2,111,147
12. Total inventoriable depreciation for 2017?
☺ - end of Module 5.1 - ☺
a. P640,000 c. P614,400
b. P580,267 d. P 0

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