ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 41 Ÿ May 2021 CPA Licensure Examination Ÿ Weeks 19-20

AUDITING (Auditing Problems) S. Ireneo Ÿ C. Espenilla

AP-600: INVESTING CYCLE: AUDIT OF INVESTMENTS

PROBLEM 1:

1. A company holds bearer bonds as a short-term investments. Responsibility for the custody of these
bonds and for the submission of coupons for periodic interest collections probably should be delegated
to the
a. Chief accountant.
b. Internal auditor.
c. Cashier.
d. Treasurer.
2. A company had temporarily excess funds to invest. The board of directors decided to purchase
marketable securities, and it assigned the future purchase and sale decisions to a responsible financial
executive. The best person(s) to make periodic reviews of the investments activity would be the
a. Investment committee of the board of directors.
b. Treasurer.
c. Corporate controller.
d. Chief operating officer.
3. If an auditor is unable to inspect and count a client’s investment securities until after the balance
sheet date, the bank in which the securities are held in a safe deposit box should be asked to
a. Verify any differences between the contents of the box and the balances in the
client’s subsidiary ledger.
b. Provide a list of securities added to and removed from the box between the
balance sheet date and the security count date.
c. Confirm that there has been no access to the box between the, balances sheet
date and the security count date.
d. Count the securities in the box so the auditor will have an independent direct
verification.
4. An auditor who physically examines securities should insist that the client representative be present in
order to
a. Detect fraudulent securities
b. Lend authority to the auditor’s directives.
c. Acknowledge the receipt of securities returned
d. Coordinate the return of securities to the proper location
5. In establishing the existence and ownership of a long-term investment in the form of publicly traded
stock, an auditor should inspect the securities or
a. Correspond with the investee company to verify the number of shares owned.
b. Inspect unaudited financial statements of the investee company
c. Confirm the number of shares owned that are held by an independent custodian
d. Determine that the investment is carried at the lower of cost or market.
6. Which of the following would provide the best form of evidence pertaining to the annual valuation of a
long-term investment in which the independent auditor’s client owns a 30 percent voting interest?
a. Market quotations of the investee company’s shares
b. Current fair value of the investee company’s assets
c. Historical cost of the investee company’s assets
d. Audited financial statements of the investee company
7. Which of the following would provide the best form of evidence pertaining to the annual valuation of a
long-term investment in which the independent auditor’s client owns a 10 percent voting interest?
a. Market quotations of the investee company’s shares
b. Current fair value of the investee company’s assets
c. Historical cost of the investee company’s assets
d. Audited financial statements of the investee company
8. In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain
the reasonableness of the
a. Completeness of recorded investment income.
b. Classification between current and noncurrent portfolios.
c. Valuation of marketable equity securities.
d. Existence of unrealized gains or losses in the portfolio.

PROBLEM 2:

Given below is a list of securities and other assets that may qualify as investment:
Bonds of another company quoted in an active market. Business
model of the company has an objective to hold debt securities for short-
term profits. 100,000

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-600
Weeks 19-20: INVESTING CYCLE: AUDIT OF INVESTMENTS

Bonds of another company quoted in an active market. Business

model of the company has an objective of collecting contractual cash-
flows from the bonds which are primarily in the form of interests and 500,000
principal.
Bonds of another company quoted in an active market. Business model has an
objective to collect contractual cash flows and to sell financial assets. 450,000
Ordinary shares of another company where no control nor significant
influence exist. The company elected to report gains or losses in the
profits/losses P100,000
Ordinary shares of another company where no control nor significant
influence exist. The company elected to report gains or losses in the
other comprehensive income/losses 150,000
20% interest in Ordinary shares of another company quoted in an active market 500,000
held to generate short-term profits
51% interest in Preference shares of another company quoted in an active 400,000
market held to generate short-term profits
50% interest in Ordinary shares of another company quoted in an active market 300,000
51% interest in Ordinary shares of another company quoted in an active market 500,000
Equity securities of the company quoted in an active market reacquired with
an intention of reissuance in latter period for short-term profit 500,000
Real property held for resale in the ordinary course of business 500,000
Real property held for speculation purposes 700,000
Real property held as a current factory site 1,000,000
Real property of a manufacturing business being leased out to another party
under operating lease 900,000
Land held for undetermined future use 800,000
Land held to be used as a future plant site 400,000
Real property being developed as an investment property 300,000
10-storey building (with each floor having equal floor size), 2 floors are used as
for administrative offices while the rest are being leased out to third parties 1,600,000
Owner-managed hotel building 1,200,000
Hotel building managed by an independent third-party where significant cash
flows from hotel is essentially through rentals derived from the third party 800,000

Requirements:
1. How much from the list above is to be categorized as financial asset at fair value through profits or
losses?

2. How much from the list above is to be categorized as financial asset at fair value through other
comprehensive income?

3. How much from the list above is to be categorized as investment at amortized cost?

4. How much from the list above is to be categorized as investment in associate?

5. How much from the list above is to be categorized as investment in subsidiary?

6. How much from the list above is to be categorized as investment property?

PROBLEM 3:

HARRIS CORP. acquired P2,000,000 face value bonds on March 31, 2019 at P1,934,336. The 10 year,
10% bonds which are dated January 1, 2013 pays annual interest every December 31 and were acquired
by the company with the intention of generating income on a short term basis from the fluctuations of the
value of the securities. The prevailing rate of interest of similar security on the same date is at 12%. The
company paid for broker’s fees and commissions amounting to P100,000. Interests collected at year-end
were credited to the appropriate interest income account. Moreover, the prevailing interest at year-end
was at 14%, thus the market value of the bonds is at P1,814,269.

REQUIREMENTS:
1. What is the unrealized holding gain or loss to be recognized in the company’s income statement for
the year?

2. What is the investment account balance as of December 31, 2019?

3. How much is the correct interest income to be recognized for the year 2019?

4. Assuming the investments were sold on July 1, 2020 at P2,050,000 what is the realized gain or loss
from the sale?

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-600
Weeks 19-20: INVESTING CYCLE: AUDIT OF INVESTMENTS

PROBLEM 4:

DIRECT CORP. acquired a three-year, 12% bonds with a face value of P1,000,000 on January 1, 2019.
The bonds which pay annual interest every December 31 had a 10% prevailing interest rate on the date
of acquisition. The investment was appropriately classified as Financial Asset at Fair Market Value
through Other Comprehensive Income/Losses. The present value factor of P1 at 10%, ordinary annuity,
for 3 periods is at 2.486852 while the present value factor of P1 at 10% for 3 periods is at 0.751315.

On December 31, 2019, the prevailing interest for similar securities is at 11%, thus the fair market value
of the bonds is at P1,017,125.

On March 31, 2020 the bonds were sold at P1,250,000. The sale was recorded as follows:

The applicable amortization schedule follows:

Nominal Effective
Date (P*Nom rate) CV*Eff ate Amortization Balance
1/1/2019 1,049,737
12/31/2019 120,000 104,974 (15,026) 1,034,711
12/31/2020 120,000 103,471 (16,529) 1,018,182
12/31/2021 120,000 101,818 (18,182) 1,000,000

REQUREMENTS:
1. What is the unrealized holding loss to be recognized in the balance sheet as of December 31, 2019?

2. What is the correct interest income to be reported in the 2019 income statement?

3. How much is the correct realized gain or loss on sale of the investment in 2020?

PROBLEM 5:

MC BEAN CORP. reported an investment in financial asset at amortized cost amounting to P10,758,157 as
of December 31, 2020 and an interest income for the year ended December 31, 2020 at P1,200,000. The
five-year, 12% bonds, which were acquired on January 1, 2019 had a face value of 10M. The bonds were
purchased at their prevailing interest rate of 10% and pays annual interest every December 31.
Records reveal that the company accounted for the investment transaction as follows:

1/1/2019 Investment at amortized cost 10,758,157

Cash 10,758,157
To record acquisition of bonds.
12/31/2019 Cash 1,200,000
Interest income 1,200,000
To record receipt of interest.
12/31/2020 Cash 1,200,000
Interest income 1,200,000
To record receipt of interest.

60% of the investment was sold on December 31, 2020 at 110 prompting the company to shift from a
business model of holding the securities primarily to collect contractual cash flow to a business model with
an objective of holding the securities for short-term profit purposes. The company is yet to record the
said disposal and shift of business model. Bonds were quoted at 115 by the end of 2021.

The applicable amortization schedule of any excess of acquisition cost over the investments’ face value
follows:
Nominal Effective
Date (P*Nom rate) CV*Eff rate Amortization Balance
1/1/19 10,758,157
12/31/19 1,200,000 1,075,816 (124,184) 10,633,973
12/31/20 1,200,000 1,063,397 (136,603) 10,497,370

REQUIREMENTS:
1. What is the adjusted gain or loss on partial disposal of the investment in 2020?
2. How much is the unrealized holding gain or loss to be reported in the 2020 Statement of
Comprehensive Income?

3. How much is the unrealized holding gain or loss to be reported in the 2021 Statement of
Comprehensive Income?

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-600
Weeks 19-20: INVESTING CYCLE: AUDIT OF INVESTMENTS

PROBLEM 6:

JACK CORP. presented the following breakdown of its investment in financial assets at fair value as of
December 31, 2019, year-end audit.:

Financial assets at fair value through profit or loss (Trading Securities):

# of shares Original Cost FMV as of
(12/31/2019)
Wan ordinary shares 15,000 P750,000 P825,000
Too preference shares 10,000 600,000 650,000
Poor preference shares 20,000 1,400,000 800,000

Financial assets at fair value through other comprehensive income (Available for Sale):
# of shares Original Cost FMV as of
(12/31/2019)
Five ordinary shares 50,000 P1,250,000 P1,500,000
Seeks ordinary shares 20,000 1,000,000 900,000

Your investigation of the accounts resulted to the following information

Shares
Acquisition orig. Original FMV as of FMV as of
Investee date acquired designation 12/31/2017 12/31/2018
Wan 6/1/2017 20,000 FVPL P1,050,000 P1,145,000
Too 11/1/2017 10,000 FVPL 750,000 700,000
Tri 2/1/2017 25,000 FVOCI 800,000 700,000
Poor 6/30/2017 20,000 FVOCI 1,300,000 1,200,000
Five 9/20/2017 50,000 FVOCI 1,125,000 1,375,000
Seeks 1/22/2017 20,000 FVOCI 1,040,000 980,000

Additional information:
a. The cost of all the securities included P1/share broker’s fees and commissions.

b. The company sold 5,000 shares of Wan ordinary shares on February 1, 2019 at P60 per share.

c. Tri ordinary shares, which were acquired at P35 per share (including P1 broker’s fees and
commissions), were sold on March 31, 2019 at P30 per share.
d. The company had an original intention of holding the investment in Poor preference shares as
financial asset at fair value through other comprehensive income. However, due to the continuing
decrease in the value of the investment, the company decided to reclassify the same as financial asset
trough profit or loss during the current year 2019. Investment in Poor was impaired at the end of
2019.

Required:
1. What is the realized gain on partial sale of Wan trading securities to be recognized in the profit or loss
in 2019?

2. What is the realized loss on sale of Tri ordinary shares to be recognized in the profit or loss in 2019?

3. How much is the impairment loss to be recognized in the profit or loss in 2019?

4. How much is the unrealized holding loss to be reported in the profit or loss in 2019?

5. How much is the unrealized holding gain or (loss) to be reported in the balance sheet as of December
31, 2019?

6. How much is the correct financial asset at fair value through profit or loss to be reported as of
December 31, 2019?

7. How much is the correct financial asset at fair value through other comprehensive income to be
reported as of Dec. 31, 2019?

PROBLEM 7:

Black Corporation owns 300,000 of White Inc.’s 1,000,000 shares issued and outstanding purchased on
January 2, 2019 at P20 per share. White’s net assets had a book value on the said date at P16M. The
excess of acquisition cost over book value of net assets acquired was attributed to the total
understatement of White’s identifiable asset without definite useful life and White’s depreciable asset with
a 5 year average useful life at P800,000 and P1,200,000, respectively. The balance of the excess was
attributed to White’s unidentifiable asset.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-600
Weeks 19-20: INVESTING CYCLE: AUDIT OF INVESTMENTS

White Inc. declared P800,000 cash dividends by the end of 2019 and reported a total comprehensive
income amounting to P2,000,000 which is net of an unrealized holding loss from its investment at fair
value through other comprehensive income amounting to P500,000.

Requirements:
1. How much investment income should be reported in Black Corporation’s profit or loss?

2. What is the carrying value of the investment in White Inc. as of December 31, 2019?

3. Assuming that White Inc. issued additional 200,000 shares at P30 per shares to other stockholders
early in January of 2020, what shall be the total gain or loss on dilution to be recognized in the 2020
profit or loss?

4. Assuming that Black Corporation sold 120,000 of its investment in White Corporation at P30 per
share, how much is the total gain on cessation should be recognized in the 2020 profit or loss?

PROBLEM 8:

Akio Corporation acquired on January 1, 2018 a real property and classified the same as an investment
property. The acquisition cost was P10,000,000 and has an estimated life of 10 years. The company paid
for a finder’s fee and commissions at P500,000.

The investment property was appraised at P12,500,000 on December 31, 2018 and P11,000,000 on
December 31, 2019.

Requirements:
Case 1: Assuming that the company uses the Fair value Method:

1. How much should the investment property be presented in the 2018 statement of financial
position?

2. How much gain/loss related to the investment should be recognized in the 2018 income
statement?

3. How much should the investment property be presented in the 2019 statement of financial
position?

4. How much gain/loss related to the investment should be recognized in the 2019 income
statement?

5. Assuming that the real property was reclassified as owner-occupied property on June 30, 2020,
when the fair value of the investment was at P10M, how much should the property be initially
recognized upon transfer?

6. Based on the previous item, how much gain/loss from reclassification should be recognized in the
income statement?

7. Assuming the real property was sold on June 30, 2020 at P10M, how much is the realized
gain/loss on the disposal?

Case 2: Assuming that the company uses the Cost Method:

1. How much should the investment property be presented in the 2018 balance sheet?

2. How much should the investment property be presented in the 2019 balance sheet?

3. Assuming that the real property was reclassified as owner-occupied property on June 30, 2020,
when the fair value of the investment was at P10M, how much should the property be initially
recognized upon transfer and how much gain/loss from reclassification should be recognized?

4. Assuming the real property was disposed on June 30, 2020 at P10M, how much is the realized
gain/loss on the disposal?

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