Auditing

Theories
1. . An auditor observed that a client mails monthly statements to customers.
Subsequently, the auditor reviewed the evidence of follow-up on the errors
reported by the customers. This test of controls most likely was performed
to support management’s financial statement assertion(s) of

Presentation and Rights and

disclosure obligations
a. Yes Yes
b. Yes No
c. No Yes
d. No No

2. Which of the following characteristics most likely would be indicative of

check-kiting?

a. High turnover of employees who have access to cash

b. Many large checks that are recorded on Mondays.
c. Low average balance compared to high level of deposits.
d. Frequent ATM checking account withdrawals.

3. In a properly designed accounts payable system, a voucher is prepared

after the invoice, purchase order, requisition, and receiving report have been verified.
The next step in the system is to

a. Cancel the supporting documents.

b. Enter the check amount in the check register.
c. Approve the voucher for payment.
d. Post the voucher amount to the expense ledger.

4. A client erroneously recorded a large purchase twice. Which of the

following internal accounting control measures would be most likely to detect this
error in a timely and efficient manner?

a. Footing the purchases journal.

b. Reconciling vendors’ monthly statements with subsidiary payable ledger accounts.
c. Tracing totals from the purchases journal to the ledger accounts.
 d. Sending written quarterly confirmations to all vendors.
You are supervising the audit property, plant and equipment of property, plant,
and equipment of Mayumi Corporation for the year ended December 31, 20X7.

For each of the preceding substantive procedures, determine the primary assertion that
is most closely related to the evidence the procedure will produce.

Questions:

1.
2.
3.
4.
5. Review the useful lives, depreciation method, and salvage values for reasonableness.
Recalculate depreciation.

a. Existence
b. Rights and Obligations
c. Completeness
d. Valuation and Allocation

6. Study loan documents for terms and security of loans obtained for purchase of Property,
Plant and Equipment.

a. Existence
b. Rights and Obligations
c. Completeness
d. Valuation and Allocation

7. Inspect title documents for automotive and real estate assets.

a. Existence
b. Rights and Obligations
c. Completeness
d. Valuation and Allocation

This caselette is designed to test your competence in the preparation of audit report.
You are the audit partner of five clients and will have to make a decision as to the
appropriate type of audit opinion that should be issued relative to their financial
statements. The pertinent data for these clients follows:

Client No. 1: Zap Batteries

During your examination of Zap Batteries, you conclude there is a possibility that
inventory is materially overstated. The client refuses to allow you to expand the scope
of your examination sufficiently to verify whether the balance is actually misstated.

Client No. 2: Gummy Sweet Company

You were engaged to examine the Gummy Sweet Company’s financial statements after
the close of the corporation’s fiscal year. Because you were engaged after the balance
sheet date, you were not able to physically observe inventory, which is highly material.
On the completion of your audit, you are satisfied that Gummy’s financial statements
are presented fairly, including inventory about which you were able to satisfy yourself
by the use of alternative audit procedures.

Client No. 3: XYZ Company

As part of your post balance sheet date audit procedures, you learned of heavy damage
to one of XYZ Company’s two plants due to a recent fire. The loss will not be reimbursed
by insurance. The newspapers described the event in detail. The financial statements
and appended notes as prepared by the client did not disclose the loss caused by the
fire. The damage plant constitutes a material portion of the total assets.

Client No. 4: Max Auto Parts Company

On January 2, 20X2, the Max Auto Parts Company receives a notice from its primary
supplier that effective immediately, all wholesale prices would be increased 10 percent.
On the basis of the notice, Max Auto Parts revalued its December 31, 20X1, inventory to
reflect the higher costs. The inventory constituted a material proportion of total assets.
The effect however of the revaluation was material to current assets but not to total
assets or net income. The increase in valuation is adequately disclosed in the footnotes.

Questions:
 a.
b.
c.
d.
e.
f.
g.
1.
2.
3.
4.
5.
6.
7.
8. The appropriate audit report on the financial statements of Client No.1 will contain

a. An unqualified opinion.
b. Either an ‘except for’ qualified opinion or disclaimer.
c. An adverse opinion.
d. A disclaimer of opinion.

1.
2.
3.
4.
5.
6.
7.
8.
9. The appropriate audit report on the financial statements of Client No.2 will contain

a. An unqualified opinion.
b. Either an ‘except for’ qualified opinion or disclaimer.
c. An adverse opinion.
d. A disclaimer of opinion.

10. The appropriate audit report on the financial statements of Client No.3 will contain
 a. An unqualified opinion.
b. Either an ‘except for’ qualified opinion or disclaimer.
c. An adverse opinion.
d. A disclaimer of opinion.

11. The appropriate audit report on the financial statements of Client No.4 will contain

a. An unqualified opinion.
b. Either an ‘except for’ qualified opinion or disclaimer.
c. An adverse opinion.
d. A disclaimer of opinion.

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12. Equipment acquisitions that are misclassified as maintenance expense most likely
would be detected by an internal control that provides for

a. Segregation of duties of employees in the accounts payable department.

b. Independent verification of invoices for disbursements recorded as equipment
acquisitions.
c. Investigation of variances within a formal budgeting system.
d. Authorization by the board of directors of significant equipment acquisitions.

e.
f.
g.
h.
 i.
j.
k.
l.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13. A company holds bearer bonds as a short-term investment. 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

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14. No employee should be able to visit the corporate safe deposit box containing
investment securities without being accompanied by another corporate employee.
What consequence might follow if this rule were not enforced?

a. An employee could pledge corporate investments as security for a short-term

personal bank loan.
b. An employee could steal securities and the theft would never be discovered.
c. It would be impossible to get a fidelity bond on the employee.
d. There would be no record of when company personnel visited the safe deposit box.

15. In establishing the existence and ownership of a long-term investment in the form of
publicly traded shares, an auditor should inspect the securities or

a. Correspond with the investees company to verify the number of shares owned.
b. Inspect the audited 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.

Auditing Problems

1. Rose company uses a calendar-year accounting period. The following information is

available about the company’s cash.
 Rose Company
Bank Reconciliation
April 30

Balance per bank statement P 4, 942

Add: Deposit in transit 610
5, 552

Deduct: Outstanding Checks

No. 606 P 177
No. 607 248 425
Correct cash balance 5, 127

Balance per books P 5, 139

Deduct: Bank service charge 12
Correct cash balance P 5, 127

First National Bank

General Account: Rose Company

Date Debits Credits Balance

4-30 4,942
5-01 610 5,552
5-02 177 5,375
5-03 248 755 1,552 5,924
5-09 489 3,621 8,619
5-12 705 1,986 9,900

First National Bank

General Account: Rose Company

Date Debits Credits Balance

5-20 930 8,970

5-22 423 8,547
 5-26 2,549 11,096
5-29 255 NSF 10,841
5-30 20 DM 5,798 5,023
5-31 14 SC 1,290 CM 6,299
Total Debits P 10,251 Total credits P 11,608

Legend: DM: Debit Memo NSF: No Sufficient Funds Check

CM: Credit Memo SC: Service Charge

Rose Company’s Cash Account

Taken from General Ledger
Cash
Balance, April 30 P 5,139 Cash Disbursement
Cash Receipts Journal, May 31 P 10,816
Journal, May 31 10,583

Information Taken from Rose Company

Cash Receipts Journal Cash Payments Journal

Cash Cash
Date Debit Date Check No. Debit
5-03 P 1,552 5-01 608 P 755
5-08 3621 5-03 609 473
5-12 1986 5-06 610 489
5-25 2549 5-11 611 705
5-31 875 5-16 612 930
P 10,583 5-21 613 243
5-27 614 511

5-29 615 5,798

5-30 616 346
5-31 617 566
P 10,816

Additional Information:

1. During May, a collection charge of P20 that was applicable to Rosal Company was
erroneously deducted by the bank from Rose Company’s account.
2. The credit memo shown on the bank statement relate to a note that the bank
collected on Rose’s behalf. The note had a face value of P 1,200 and Rose earned
 interest of P90 during the current accounting period. The company has not yet
recorded the collection.
3. Rose failed to record the bank service charge for April (see April reconciliation).
4. The NSF shown on the bank statement had been received during May from a
customer on account. The return of the check has not yet been recorded by Rose.
5. Rose made two errors in recording cash payments during May:

Actual Amount Amount

Check No. Of Check Recorded
609 P 437 P 473
613 423 243

Check No. 609 was for delivery expense; check no. 613 was issued to purchase equipment.

Required: Prepare a bank reconciliation dated May 31. ( 5 pts. )

1.
2. The cash account of Dolly, Inc., disclosed a balance of P 17,056.48 on October 31. The
bank statement as of October 31 showed a balance of P 21,209.45. Upon comparing the
statement with the cash records, the following facts were developed.

a. Dolly’s account was charged on October 26 for a customer’s uncollectible check

amounting to P 1,143.
b. A 2-month 9% P 3,000 customer’s note dated August 25, discounted on October
12 was dishonored October 26 and the bank charged Dolly P 3,050.83, which
included a protest fee of P 5.83.
c. A customer’s check for P 725 was entered as P 625 by both the depositor and the
bank but was later corrected by the bank.
d. Check No.661 for P 1,242.50 was entered in the cash disbursements journal at P
1,224.50 and Check No. 652 for P 32.90 was entered as P 329.00. The company
uses the voucher system.
e. Bank service charges of P 39.43 for October were not yet recorded on the books.
f. A bank memo stated that M. Sin’s note for P 2,500 and interest of P 62.50 had
been collected on October 29, and the bank charged P 12.50. (No entry was
made on the books when the note was sent to the bank for collection.)
g. Receipts of October 29 for P 6,850 were deposited November 1.

The following checks were outstanding on October 31:

 No.620………………………. P 1, 250.00 No.620………………………. P 732.50
No.621………………………. 3,448.23 No.621………………………. 187.90
No.632………………………. 2,405.25 No.632………………………. 275.72
No.670………………………. 1,775.38 No.670………………………… 2,233.15

The bank reconciliation as of October 31 will show an adjusted cash balance of

a. P 21,209.45 c. P 28,059.45
b. P 15,751.32 d. P 17,056.48

3. You were engaged to audit the books of accounts of A. Bonifacio Contractors which
had a 3-year construction contract in 20X7 for P 900,000. A. Bonifacio uses the
percentage-of-cost-completion method for financial statement purposes. Income to
be recognized each year is based on the ratio of cost incurred to total estimated cost
to complete the contract. Data on this contract follows:

Accounts receivable construction contract billings P 30,000

Construction in progress 93,750
Less: Amounts billed 84,375
10% retention 9,375
Net income recognized in 20X7 (before tax) 15,000

A. Bonifacio Contractors maintains a separate bank account for each construction

contract. Bank deposits to this contract amounted to P 50,000.

1. How much cash collected on the contract that was not deposited as at December
31, 20X7?
a. P 4,375 c. P 19,375
b. P 13,750 d. P 28,750

2. What was the estimated total income before tax on this contract?

a. P 45,000 d. P 144,000
b. P 94,000 e. None of these
c. P 135,000
4. You observed the inventory count of the Solsons Company as of December
31, 20X7. The client prepared the summary presented below and gave it to you for
verification:

Quantity Cost Market Amount

A 360 units P 3.60/doz. P 3.64/doz. P 1,310.4
B 24 units P 4.70 each 4.80 each 112.80
C 28 units 16.50 each 16.50 each 1,353.00
D 43 units 5.15 each 5.20 each 176.80
E 400 units 9.10 each 8.10 each 3,640.00
F 70 dozens 2.00 each 2.00 each 140.00
G 95 grosses 144.00/gross 132.00/gross 13,780.00

Questions:
1. You determine from your examination that the proper value for Item A should be

a. P 1, 250 c. P 1,526
b. P 1,296 d. P 108

2. You have also determined that the value for Item E is

a. correct c. P 3,240
b. P 1,526 d. P 108

3. Based on your findings, Item C should be valued at

a. P 12,380 c. P 13,680
b. P 12,540 d. P 462

4. Based on your working papers, the proper value of the inventory as of December
31, 20X7 is

a. P 18,364.25 c. P 20,513.20
b. P 19,604.25 d. P 20,315.00

5. Your client furnished you with the following data:

Merchandise Inventory, January 1 P 60,000
Purchases, January 1 to October 1 415,000
Purchases returns and allowances 5,000
Transportation in 10,000
Sales, January 1 to October 31, at 35% above
cost 540,000
Merchandise not damaged by fire on
October 31 42,000
 Using the gross profit test, what was the estimated loss in inventory due to the fire?

a. P 38,000 c. P 80,000
b. P 60,000 d. None of these

6. Greg Inc. began operations on January 1, 20X7. The following data pertain to the
company’s first two years in business:

Reported Amount Correct Amount

Inventory
Dec. 31, 20x6 P 20,000 P 40,000
Dec. 31, 20x7 35,000 35,000

Net Income
For 20X6 60,000 ?
For 20X7 66,000 ?

Retained earnings
Dec. 31, 20x6 60,000 ?
Dec. 31, 20x7 120,000 ?

During 20X6 and 20X7 the company’s income tax expense rate was 40% and the
company declared no dividends.

Instructions: Compute the correct amount for each of the following items: ( 4 pts. )
a. Net Income for 20X6.
b. Net Income for 20X7.
c. Retained Earnings, December 31, 20X6.
d. Retained Earnings, December 31, 20X7

7. On June 30, 20X7 Fiesta Company purchased 25% of the outstanding ordinary shares of
XY Co. at a total cost of P 2,100,000. The book value of XY Co.’s net assets on acquisition
date was P 7,200,000. For the following reasons, Fiesta was willing to pay more than the
book value for the XY Co. stock:

 XY Co. has depreciated assets with a current fair value of P 180,000 more than
their book value. These assets have remaining useful life of 0 years.
  XY Co. owns a tract of land with a current fair value of P 900,000 more than its
carrying amount.
 All other identifiable tangible and intangible assets of XY Co. have current fair
values that are equal to their carrying amounts.

XY Co. reported net income of P 1,620,000 earned evenly during the current year ended
December 31, 20X7. Also in the current year, it declared and paid cash dividends od P
315,000 to its ordinary shareholders. Market value of XY Co.’s ordinary shares at
December 31, 20X7, is P 9.5 million. Fiesta Company’s financial year-end is December
31.

Questions:
1. What is the total amount of goodwill of XY Co. based on the price paid by Fiesta
Company?

a. P 78,750 c. P 228,750
b. P 202,500 d. P 71,250

2. What amount of investment revenue should Fiesta report on its income statement
for the year ended December 31, 20X7, under the cost method?

a. P 78,750 c. P 78,500
b. P 202,500 d. P 123,750

3. What amount of investment revenue should Fiesta report on its income statement
for the year ended December 31, 20X7, under the equity method?

a. P 202,500
b. P 200,250
c. P 78,750
d. P 123,750

4. Under the equity method, the carrying value of the Fiesta Company’s investment in
ordinary shares of XY Co. on December 31, 20X7, should be

a. P 2,221,500
b. P 2,100,000
 c. P 2,070,000
d. P 2,250,000

5. What amount should Fiesta Company report on its December 31, 20X7, balance
sheet as its investments in XY Co. under the cost/fair value method?

a. P (275,000)
b. P 375,000
c. P 221,500
d. P 100,000

8. A machine with a marked price of P 50,000 was purchased 2/10 net 60, on July 10,
20X7s. It was fully paid on September 5, 20X7. In addition, freight charges of P 350 and
installation cost of P 1,020 were incurred. The old machine replaced was sold at a loss of
P 500. The Company’s accountant recorded the asset at a cost of P 49,870.

The auditor, you, will propose adjustment as follows:

a. Decrease the Machinery account by P 1,020.
b. Increase the Machinery account by P 500.
c. No adjustment is necessary.
d. None of these.

(PhilCPA adapted)

9. Beth Company leased equipment to Wolf, Inc. on April 1, 20X7. The lease is
appropriately recorded as sale foe accounting purposes for Beth. The lease is for an
eight year ( 8 ) period expiring March 1, 20X5. The first equal annual payment of P
500,00 was made on APRIL 1, 20X7. Beth had purchased the equipment on January 1,
20X7 for P 2,800,000. The equipment has an estimated useful life of eight years with no
residual value expected. Beth uses straight-line depreciation in the year of purchase.
The cash selling price of the equipment is P 2,934,000. Assuming an interest rate of 10%,
what amount of interest income should Beth record in 20X7 as a result of the lease?

a. P 0 d. P 280,000
b. P 182,550 e. P 293,400
c. P 243,000
10. The Building account of Emily Company includes the following items on December 31,
20X7.

Building
Contract Price 225,000 Gain on sale of old 17,500
Options 7,000 building
Repair and
Maintenance 12,000

The building was acquired in early 20X7 and all entries have been made since the
acquisition. The options include P 5,000 on the building acquired and P 2,000 on a
building which was not acquired. Repair and maintenance costs relate to routine
activities occurring after the building was occupied.

Instructions:
a. Prepare the entry ( or entries ) needed to correct the Building account on
December 31, 20X7, before the books are closed.
b. Determine depreciation expense for 20X7 using each of the following methods,
assuming a 20-year life and P 80,000 salvage value. A half-year depreciation is
taken in the year of acquisition and the year of disposal.
1. Straight line
2. Sum-of-the-year’s-digits
3. Double-declining balance
4.
5.
6.
7.
8.
9.
10.
( 5 pts. )

11. The Plaza Company was organized late in 20X6 and began operations on January 1,
20X7. Plaza is engaged in conducting market research studies on behalf of
manufacturers. Prior to the start of operations, the following costs were incurred:

Attorney’s fees in connection with the organization of Plaza P 4,000

Improvements to leased offices prior to occupancy 7,000
 Meetings of incorporators, filing fees and other
organization expenses 5,000
P 16,000

What is the amount of organization costs amortized for 20X7?

a. P 9,000 c. P 1,800
b. P 400 d. P 3,200
(AICPA adapted)

12. On January 1, the lessor company purchased a piece of equipment for P 10,000. The
equipment has an expected life of 5 years with zero salvage value. The lessor company
immediately leased the equipment under an operating lease agreement. The lease calls
for the lessor company to receive lease payments of P 2,600 per year to be received at
the beginning of the year.

Required:

Make the journal entries necessary on the books of the lessor company to record (1) the
purchase of the equipment for cash, (2) the lease signing (including receipt of the first
payment), and (3) depreciation of the leased equipment. (3 pts.)

13. Analen Corporation was organized on January 3, 20X7, with authorized capital of 50,000
shares of P 10 par value ordinary shares. During 20X7 Analen had the following
transactions affecting shareholders’ equity:

January 7 – Issued 20,000 shares @ P 12 per share

December 31 – Purchased 3,000 treasury shares @P 13 per share

The cost method was used to record the treasury shares transaction. Analen’s net
income for 20X7 is P 150,000. What is the amount of shareholders’ equity at December
31, 20X7?
a. P 320,000 c. P 354,000
b. P 351,000 d. P 360,000

(AICPA adapted)3
14. During 20X6 Chris Corporation issued for P 110 per share, 5,000 shares of P 100 par
value convertible preference shares. One preference share can be converted into three
shares of Chris P 25 par ordinary shares at the option of the preference shareholder. On
December 31, 20X7, all of the preference shares were converted into ordinary shares.
The market value of the ordinary shares at the conversion date was P 40 per share.
What amount should be credited to the ordinary shares account on December 31, 20X7?

a. P 375,000 c. P 550,000
b. P 500,000 d. P 600,000

15. An analysis of shareholders’ equity of Medina Corporation as of January 1, 20X7 is as

follows:

Ordinary shares, par value P 20; authorized

100,000 shares; issued and outstanding 60,000 shares P 1,200,00
Capital in excess of par value 140,000
Retained earnings 760,000
Total P 2,100,000

Medina uses the cost method of accounting for treasury shares and during 20X7 entered
into the following transactions:

 Acquired 1,000 of its shares for P 35,000.

 Sold 600 treasury shares at P 38 per share
 Retired the remaining treasury shares.

Assuming no other equity transactions occurred during 20X7 what should Medina report
at December 31, 20X7 as capital in excess of par value?

a. P 156,800 c. P 140,000
b. P 150,800 d. P 135,800