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AUDITING PROBLEMS
DIAGNOSTIC EXAMINATION OCTOBER 2020 CPALE

INSTRUCTION: Select the correct answer for each of the e) Due to the carelessness of the
following questions. Mark only one answer for each item receiving department, a December
by shading the box corresponding to the letter of your shipment was damaged by rain.
choice on the answer sheet provided. STRICTLY NO These goods were later sold at cost 40,000
ERASURES ALLOWED. in December.

SITUATIONAL Based on the preceding information, determine the

following:
SITUATION 1
QUESTIONS:
PRTC, Inc. is an importer and wholesaler of cellphone
1. Adjusted net purchases
accessories. Its merchandise is purchased from a number
A. Up to November 30: P2,666,000;
of suppliers and is warehoused until sold to customers.
Up to December 31: P3,190,000
B. Up to November 30: P2,700,000;
In conducting your audit of PRTC’s financial statements
Up to December 31: P3,164,000
for the year ended December 31, 2020, you determined
C. Up to November 30: P2,696,000;
that the internal control system is functioning effectively.
Up to December 31: P3,186,000
You observed the physical count of inventory on
D. Up to November 30: P2,704,000;
November 30, 2020.
Up to December 31: P3,184,000
The following information were obtained from PRTC’s 2. Gross profit ratio for 11 months ended November 30,
accounting records: 2020
A. 21.58% C. 21.47%
Sales for 11 months ended November 30 P3,400,000 B. 20.94% D. 20.82%
Sales for the year ended December 31 3,840,000
Purchases for 11 months ended Nov. 30 2,700,000 3. Gross profit for the month of December 2020
Purchases for the year ended Dec. 31 3,200,000 A. P92,136 C. P83,760
Inventory, January 1 350,000 B. P91,236 D. P88,000
Inventory, Nov. 30 (per physical count) 380,000 4. Estimated inventory at December 31, 2020
A. P491,760 C. P490,000
Your audit disclosed the following information: B. P456,000 D. P455,120
a) Shipments received in unsalable 5. An auditor selected items for test counts while
condition and excluded from physical observing a client’s physical inventory. The auditor
inventory. The returns were not then traced the test counts to the client’s inventory
recorded because no credit memos listing. This procedure most likely obtained evidence
were received from vendors: concerning
Total at November 30 P 4,000 A. Existence. C. Rights.
Total at December 31 B. Completeness. D. Valuation.
(including the November 30
unrecorded returns) 6,000
b) Deposit made with vendor and charged SITUATION 2
to Purchases in October. The goods
were shipped in January 2021. 8,000 In the audit of the books of Manila Corporation for the
c) Deposit made with vendor and charged year 2020, the following items and information appeared
to Purchases in November. The in the Production Machine account of the client:
goods were shipped FOB destination Date Particulars Debit Credit
on November 29 and were included 01/01 Balance–Machine 1, 2,
in physical inventory as goods in 3, and 4 at P180,000 P 720,000
transit. 22,000 each
d) Shipments received in November and 02/28 Machine 5 396,000
included in the physical count at Machine 1 P 6,000
November 30 but recorded as 09/01 Machine 6 192,000
December purchases. 30,000 12/01 Machine 7 432,000

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The Accumulated Depreciation account contained no Amount

entries for the year 2020. The balance on January 1, Date (in Php) Additional information
2020 per your audit, was as follows: 1 Jan. 2020 200,000,000 20 per cent of the price
Machine 1 P168,750 is attributable to the
Machine 2 78,750 land
Machine 3 67,500 1 Jan. 2020 20,000,000 Non-refundable transfer
Machine 4 45,000 taxes (not included in
the P200,000,000
Based on your further inquiry and verification, you noted purchase price)
the following: 1 Jan. 2020 1,000,000 Legal costs directly
1. Machine 5 was purchased for cash; it replaced attributable to the
Machine 1, which was sold on this date for P6,000. acquisition
2. Machine 2 was destroyed by the thickness of engine 1 Jan. 2020 10,000 Reimbursing the
oil used leading to explosion on December 1, 2020. previous owner for
Machine 7 was to replace Machine 2. prepaying the non-
3. Machine 3 was traded in for Machine 6 at an refundable local
allowance of P24,000; the difference was paid in cash government property
and charged to Production Machine account. taxes for the six-month
4. Depreciation rate is recognized at 25% per annum. period ending 30 June
2020
QUESTIONS: 1 Jan. 2020 500,000 Advertising campaign to
attract tenants
Based on the above and the result of your audit, answer 2 Jan. 2020 200,000 Opening function to
the following: celebrate new rental
business that attracted
6. The gain or loss on sale of Machine 1 is
extensive coverage by
A. P6,000 gain C. P1,500 loss
the local press
B. P5,250 loss D. P2,250 gain
30 June 2020 20,000 Non-refundable annual
7. The loss on trade in of Machine 3 is local government
A. P58,500 C. P51,000 property taxes for the
B. P54,750 D. P88,500 year ending 30 June
2021
8. The Production Machine account is overstated by
Throughout 120,000 Day-to-day repairs and
A. P534,000 C. P714,000
2020 maintenance, including
B. P510,000 D. P690,000
the salary and other
9. The total depreciation for the year ended December costs of the
31, 2020 is administration and
A. P237,000 C. P233,250 maintenance staff.
B. P232,500 D. P236,250 These costs are
attributable equally to
10. The carrying amount of production machine as of each of the ten units.
December 31, 2020 is
A. P1,024,500 C. P1,069,500 The entity uses one of the ten units to accommodate its
B. P1,029,000 D. P 990,750 administration and maintenance staff. The other nine
units are rented to independent third parties under non-
cancellable operating leases.
SITUATION 3
Davao Corporation, a real estate entity, has total assets of At 31 December 2020, the entity made the following
not more than P350 million and total liabilities of not more assessments about the units:
than P250 million. Davao’s debt and equity instruments • Useful life of the buildings: 50 years from the date
are not traded in a public market. of acquisition
• The entity will consume the buildings’ future
Davao Corporation incurred (and paid) the following economic benefits evenly over 50 years from the
expenditures in acquiring property consisting of ten date of acquisition.
identical freehold detached houses each with separate
legal title including the land on which it is built: The fair value of the units can be determined reliably
without undue cost or effort on an ongoing basis and that
the residual value of the owner-occupied unit is nil.

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At 31 December 2020 the fair value of each unit was b. On May 1, 2020, Bacolod sold Patent B in exchange for
reliably estimated as P25,000,000. a P5,000,000 non-interest bearing note due on May 1,
2023. There was no established exchange price for the
QUESTIONS: patent, and the note had no ready market. The
prevailing rate of interest for a note of this type at May
Based on the above and the result of your audit, answer
1, 2020 was 14%. The patent was purchased for
the following as of and for the year ended December 31,
P3,150,000 on September 1, 2016. On that date, the
2020:
remaining legal life was fifteen years, which was also
11. Davao Corporation is a _________ determined to be the useful life.
A. Large entity
c. On January 3, 2020, in connection with the purchase of
B. Medium-sized entity
a trademark from Joe Corporation, the parties entered
C. Small entity
into a noncompetition agreement and a consulting
D. Micro entity
contract. Bacolod paid Joe P8,000,000, of which
12. How much should be reported as property, plant and three-quarters was for the trademark and one-quarter
equipment? was for Joe’s agreement not to compete for a five-year
A. P21,747,384 C. P 21,746,400 period in the line of business covered by the
B. P21,648,000 D. Nil trademark. Bacolod considers the life of the trademark
to be indefinite. Under the consulting contract,
13. How much should be recognized in profit or loss Bacolod agreed to pay Joe P500,000 annually on
regarding the increase in fair value of investment January 3 for five years. The first payment was made
properties? on January 3, 2020.
A. P26,100,000 C. P27,000,000
B. P26,091,000 D. P29,636,000 d. At December 31, 2020, Bacolod determined the
14. How much is the total expense to be recognized in recoverable amount of the intangible assets as follows:
profit or loss? Patent A P1,350,000
A. P1,193,616 C. P1,193,600 Trademark 5,500,000
B. P2,192,000 D. P4,376,000 Noncompetition agreement 1,800,000
15. Assume that the fair value of the units cannot be
determined reliably without undue cost or effort on an
QUESTIONS:
ongoing basis, how much is the total expense to be
recognized in profit or loss? Based on the above and the result of your audit,
A. P5,360,000 C. P4,366,000 determine the following:
B. P4,376,000 D. P4,376,160
16. Gain on sale of Patent B
A. P2,620,000 C. P 995,000
SITUATION 4 B. P1,012,500 D. P 977,500

The statement of financial position of Bacolod Corporation 17. Total amortization to be recognized in 2020
as of December 31, 2019 reported the Intangible Assets, A. P680,000 C. P 767,500
net as follows: B. P750,000 D. P1,950,000

Patent A P1,680,000 18. Total impairment loss to be recognized in 2020

Patent B 2,450,000 A. P750,000 C. P550,000
P4,130,000 B. P620,000 D. P 50,000
19. Intangible assets to be recognized in the statement of
During the course of your audit, you noted the following. financial position as of December 31, 2020
a. Patent A was purchased for P1,920,000 on January 1, A. P7,750,000 C. P8,450,000
2018, at which date the remaining legal life was B. P7,950,000 D. P8,850,000
sixteen years. On January 1, 2020, Bacolod 20. In auditing intangible assets, an auditor most likely
determined that the useful life of the patent was only would review or recompute amortization and
eight years from the date of acquisition. determine whether the amortization period is
reasonable in support of management’s financial
statement assertion of
A. Valuation. C. Existence
B. Completeness. D. Rights

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SITUATION 5 QUESTIONS:
You were able to gather the following from the December Based on the above and the result of your audit, compute
31, 2020 trial balance of Santiago Corporation in for the adjusted balances of following:
connection with your audit of the company:
21. Cash on hand
Cash on hand P 372,000 A. P282,000 C. P408,000
Petty cash fund 10,000 B. P246,000 D. P342,000
BPI current account 950,000
22. Petty cash fund
Security Bank current account No. 01 1,280,000
A. P6,700 C. P 2,100
Security Bank current account No. 02 (40,000)
B. P9,100 D. P10,000
PNB savings account 500,000
PNB time deposit 300,000 23. BPI current account
A. P1,086,000 C. P1,000,000
Cash on hand includes the following items: B. P 914,000 D. P 950,000
a. Customer’s check for P60,000 returned by bank on 24. Cash and cash equivalents
December 26, 2020 due to insufficient fund but A. P2,914,700 C. P2,614,700
subsequently redeposited and cleared by the bank on B. P2,954,700 D. P3,414,700
January 8, 2021.
b. Customer’s check for P30,000 dated January 2, 2021, 25. Which of the following balance-related audit
received on December 29, 2020. objectives typically is assessed as having high
c. Postal money orders received from customers, inherent risk for cash?
P36,000. A. Presentation and disclosure
B. Valuation
The petty cash fund consisted of the following items as of C. Cutoff
December 31, 2020. D. Existence

Currency and coins P 2,100

Employees’ vales 1,600 SITUATION 6
Currency in an envelope marked “collections
for charity” with names attached 1,200 The Cavite Corp. sells direct to retail customers and also
Unreplenished petty cash vouchers 800 to wholesalers. Accounts receivable and an allowance for
Check drawn by Santiago Corporation, bad debts are maintained separately for each division. On
payable to the petty cashier 4,600 January 1, 2020 the balance of the retail accounts
P10,300 receivable was P209,000 while the bad debts with respect
to retail customers was a credit of P7,600.
Included among the checks drawn by Santiago
Corporation against the BPI current account and recorded The following summary pertains only to retail sales since
in December 2020 are the following: 2017:
Bad Debts Bad Debts
a. Check written and dated December 29, 2020 and
Credit Sales Written Off Recoveries
delivered to payee on January 2, 2021, P50,000.
2017 P1,110,000 P26,000 P2,150
b. Check written on December 27, 2020, dated January
2018 1,225,000 29,500 3,750
2, 2021, delivered to payee on December 29, 2020,
2019 1,465,000 30,000 3,600
P86,000.
2020 1,500,000 31,000 4,200
The credit balance in the Security Bank current account
Bad debts are provided for as a percentage of credit sales.
No. 2 represents checks drawn in excess of the deposit
The accountant calculates the percentage annually by
balance. These checks were still outstanding at December
using the experience of the three years prior to the
31, 2020.
current year. The formula is bad debts written off less
recoveries expressed as a percentage of the credit sales
The savings account deposit in PNB has been set aside by
for the same period. Cash receipts in 2020 from credit
the board of directors for acquisition of new equipment.
sales to retail customers was P1,380,200.
This account is expected to be disbursed in the next 3
months from the balance sheet date.

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QUESTIONS: • On July 1, 2020, the entity sold half of the

investment for its fair value of P800,000.
Based on the above and the result of your audit, answer
• Fair value of the investment: December 31, 2018,
the following:
P1,200,000; December 31, 2019, P1,500,000;
26. The percentage to be used to compute the allowance December 31, 2020, P900,000.
for bad debts on December 31, 2020 is
A. 1% C. 2% Investment in Bonds
B. 1.9% D. 3% • The entity uses the ‘held for collection’ business
model for acquired and originated debt instruments.
27. For 2020, the provision for bad debts with respect to • P1,000,000, 10% bonds, purchased for P1,051,510
credit sales is including transaction costs of P20,000. Interest is
A. P28,802 C. P30,000 payable annually every December 31. The bonds
B. P45,000 D. P57,604 mature on December 31, 2022..
28. The ledger balance of the accounts receivable after • The prevailing market rate for the bonds is 9% at
necessary adjustments on December 31, 2020 was a December 31, 2020.
debit of
A. P275,396 C. P303,000 QUESTIONS:
B. P288,000 D. P297,800 Based on the above and the result of your audit, answer
29. The ledger balance of the allowance for bad debts the following:
after necessary adjustments on December 31, 2020 31. The carrying amount of Investment in Ordinary
was a credit of Shares as of December 31, 2020 is misstated by
A. P10,800 C. P25,800 A. P200,000 over C. P50,000 over
B. P 6,600 D. P31,800 B. P200,000 under D. P50,000 under
30. All of the following are examples of substantive tests 32. The effective interest rate on Investment in Bonds is
to verify valuation of net accounts receivable except A. 7% C. 9%
the B. 8% D. 10%
A. Re-computation of the allowance for bad debts.
B. Inspection of the aging schedule and credit 33. The carrying amount of Investment in Bonds as of
records of past due accounts. December 31, 2020 is overstated by
C. Comparison of the allowance for bad debts with A. P13,900 C. P18,020
past records. B. P15,880 D. P33,900
D. Inspection of accounts for current versus non-
34. The net amount to be recognized in 2020 profit or loss
current status in the statement of financial
related to these investments is
position.
A. P384,121 C. P134,121
B. P284,121 D. P114,121
SITUATION 7 35. Which statement is correct regarding audit of
investment securities?
Laguna Corporation’s accounting records included the
A. An auditor’s audit objective is to determine
following investments:
whether the securities are authentic.
Investment in Ordinary Shares B. Examination of paid checks issued in payment of
1/1/18 P1,000,000 7/1/20 P800,000 securities purchased is the most effective
12/31/18 200,000 procedure to verify existence.
12/31/19 300,000 C. In performing tests of the carrying amount of
investments in equity securities, the auditor would
usually refer to the quoted market prices of the
Investment in Bonds
securities.
1/1/20 P1,051,510
D. If a client has a large and active investment
portfolio that is kept in a bank safe-deposit box
and the auditor is unable to count the securities at
During the course of your audit, you noted the following.
the end of the reporting period, the auditor most
likely will request the bank to confirm to the
Investment in Ordinary Shares
auditor the contents of the safe deposit box at the
• The investment is not designated at FVTOCI.
end of the reporting period.
• Acquired on January 1, 2018 at P950,000 plus
transaction costs of P50,000.

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SITUATION 8 The accrual method is used by Cebu to account for the

warranty and premium costs for financial reporting
Cebu Music Emporium carries a wide variety of music
purposes. The balance in the accounts related to
promotion techniques - warranties and premiums – to
warranties and premiums on January 1, 2020, were as
attract customers.
shown below:
Musical instrument and sound equipment are sold in a Inventory of Premium AM/FM radio P 39,950
one-year warranty for replacement of parts and labor. Estimated Premium Claims Outstanding 44,800
The estimated warranty cost, based on past experience, is Estimated Liability from Warranties 136,000
2% of sales.
QUESTIONS:
The premium is offered on the recorded and sheet music.
Based on the above and the result of your audit,
Customers receive a coupon for each peso spent on
determine the amounts that will be shown on the 2020
recorded music or sheet music. Customers may exchange
financial statements for the following:
200 coupons and P20 for an AM/FM radio. Cebu pays P34
for each radio and estimates that 60% of the coupons 36. Warranty expense
given to customers will be redeemed. A. P108,000 C. P164,000
B. P144,000 D. P80,000
Cebu’s total sales for 2020 were P7,200,000 - P5,400,000
from musical instrument and sound reproduction 37. Estimated liability from warranties
equipment and P1,800,000 from recorded music and A. P108,000 C. P136,000
sheet music. Replacement parts and labor for warranty B. P164,000 D. P80,000
work totaled P164,000 during 2020. A total of 6,500 38. Premium expense
AM/FM radio used in the premium program were A. P 75,600 C. P108,000
purchased during the year and there were 1,200,000 B. P183,600 D. P126,000
coupons redeemed in 2020.
39. Inventory of AM/FM radio
A. P46,950 C. P77,350
B. P39,950 D. P56,950
40. Estimated liability for premiums
A. P75,600 C. P63,450
B. P36,400 D. P44,800

SITUATION 9
CDO Corporation was organized on January 1, 2018, and began operations immediately. Unfortunately, the company
hired an incompetent bookkeeper. For the years 2018 through 2020, the bookkeeper presented an annual balance
sheet that reported only one amount for shareholders' equity. Also, the condensed income statement reported as
follows: 2018, net loss, P175,000; 2019, net profit, P220,000; and 2020, net profit, P410,000. The president has
recommended to the board of directors that a cash dividend of P450,000 be declared and paid during January 2021.
The outside director on the board has objected on the basis that the company's financial statements contain major
errors (there has never been an audit). You have been engaged to clarify the situation. The single shareholders' equity
account, provided by the bookkeeper, appeared as follows:
Shareholders' Equity
2018 Share issue costs P 15,000 2018 Ordinary shares, par P5
2018 Net loss 175,000 200,000 shares issued P1,600,000
2019 Bought 10,000 shares from an unhappy 2019 Net profit (including P100,000
shareholder X 70,000 land write-up based on
president’s estimate) 220,000
Depreciation expense* 2019 Ordinary shares, 2,000
(2018, P15,000; 2019, P17,000; 2020, shares issued 18,000
P23,000) 55,000
Miscellaneous expenses* 2020 Sold 5,000 of X’s shares 27,000
(2018, P20,000; 2019, P25,000; 2020,
P5,000) 50,000
2020 Cash loan to the company president 200,000 2020 Net profit 410,000
P565,000 P2,275,000
* Recorded as expense but not shown on the income statement.

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QUESTIONS: Naga Company

Statement of Cash Flows
Based on the above and the result of your audit,
For the Year Ended December 31, 2020
determine the adjusted balances of following as of
December 31, 2020: Cash flows from operating activities:
Cash collected from
41. Share capital customers P685,300
A. P 985,000 C. P1,603,000
Cash payments for:
B. P1,010,000 D. P1,618,000
Inventory purchases P300,000
42. Share premium General expenses 102,000
A. P593,000 C. P601,000
Wages expense 150,000
B. P595,000 D. P608,000
Interest expense 11,000
43. Retained earnings Income tax expense 23,900 586,900
A. P342,000 C. P242,000 Net cash provided by
B. P250,000 D. P227,000 operating activities P 98,400
44. Total equity Cash flows from investing activities:
A. P1,980,000 C. P1,810,000 Sale of property, plant, and
B. P1,896,000 D. P1,710,000 equipment P 27,200
Purchase of property, plant,
45. An auditor usually obtains evidence of shareholders’ and equipment (60,000)
equity transactions by reviewing the entity’s
Net cash used in investing
A. Canceled stock certificates.
activities (32,800)
B. Transfer agent’s records.
Cash flows from financing activities:
C. Treasury stock certificate book.
D. Minutes of board of directors meetings. Retirement of bonds payable P(23,000)
Payment of dividends (42,000)
Net cash used in financing
SITUATION 10 activities (65,000)
The following financial statements are for Naga Company. Net increase in cash P 600
Cash at the beginning of the year 3,400
Naga Company
Comparative Statements of Financial Position Cash at the end of the year P 4,000
December 31, 2020 and 2019 Consider the following additional information:
(a) All accounts payable relate to inventory purchases.
2020 2019
(b) Property, plant, and equipment sold had an original
Assets cost of P75,000 and a carrying amount of P22,000.
Cash P 4,000 P 3,400
Accounts receivable 25,000 18,000 QUESTIONS:
Inventory 30,000 34,000 Based on the foregoing, compute the following for the
Prepaid general expenses 5,700 5,000 year ended December 31, 2020:
Properly, plant, and equipment 305,000 320,000
Accumulated depreciation (103,500) (128,900) 46. Cost of goods sold
Patent 36,000 40,000 A. P307,000 C. P299,000
B. P300,000 D. P293,000
Total assets P302,200 P291,500 47. Depreciation expense
A. P27,600 C. P53,000
Liabilities and Equity B. P25,400 D. P78,400
Accounts Payable P 25,000 P 22,000
48. Total operating expenses
Wages Payable 12,000 10,300
A. P282,400 C. P310,000
Interest Payable 2,800 4,000
B. P284,600 D. P335,400
Dividends Payable 14,000 -
Income taxes Payable 1,600 1,200 49. Loss on retirement of bonds payable
Bonds Payable 100,000 120,000 A. P 3,000 C. P23,000
Share capital 50,000 50,000 B. P20,000 D. P 0
Retained Earnings 96,800 84,000
50. Net income
Total Liabilities and
A. P12,800 C. P40,800
Shareholders' Equity P302,200 P291,500
B. P54,800 D. P68,800
J - end - J

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