Applied Auditing
Prof. J.M. Tang
Audit of Liabilities
2
ndSemester – SY 2013-2014
Problem 1: Current and Noncurrent Liabilities
In the audit of the Alpha Corporation’s financial statements at December 31, 2013, the chief accountant of the said corporation provided the following information:
Notes payable:
Arising from purchase of goods 120,000
Arising from bank loans, on which marketable securities valued at P600,000 have pledged as security, due Dec. 31, 2014
500,000
Arising from advances by officers, due June 30, 2014 50,000
Reserve for general contingencies 400,000
Employees’ income tax withheld 20,000
Advances received from customers on purchase orders 64,000
Containers’ deposit 50,000
Accounts payable arising from purchase of goods, net of debit balances of P30,000 170,000
Accounts receivable, net of credit balances P40,000 360,000
Cash dividends payable 80,000
Stock dividends payable 100,000
Dividends in arrears on preferred stock, not yet declared 200,000
Convertible bonds, due January 31, 2015 1,000,000
First mortgage serial bonds, payable in semi-annual installments of P50,000, due April 1 and
October 1 of each year 2,000,000
Overdraft with Allied Bank 90,000
Cash in bank balance with PNB 390,000
Estimated damages to be paid as a result of unsatisfactory performance on a contract 160,000 Estimated expenses on meeting guarantee for service requirements on merchandise sold 120,000
Accrued interest on bonds payable 360,000
Common stock warrants outstanding 120,000
Common stock options outstanding 210,000
Unused letters of credit 80,000
Deficiency income tax assessment being contested 500,000
Notes receivable discounted 200,000
Based on the above and result of your audit, determine the following: 1. Total current liabilities
2. Total noncurrent liabilities 3. Total liabilities
Problem 2: Cut-off Test
In conjunction with your firm’s examination of the financial statements of Beta Company as of December 31, 2013, you obtained from the voucher register the information shown in the working paper below.
Item
No. Entry Date Voucher Ref. Description Amount Account Charged
1 12.18.13 12-202 Supplies, purchased FOB destination,
2 12.18.13 12-204 Auto insurance, 12.15.13 to 12.15.14 24,000 Prepaid insurance
3 12.21.13 12-206 Repair services; received 12.20.13 24,000 Repairs and maintenance
4 12.21.13 12-214 Merchandise shipped FOB shipping point, 11.20.13; received, 12.4.13
17,000 Inventory
5 12.21.13 12-219 Payroll, 12.6.13 to 12.20.13
(12 working days) 69,000 Salaries and wages
6 12.26.13 12-221 Subscription to tax reporting service for 2014
5,000 Dues and subscription expense
7 12.28.13 12-230 Utilities for December 2013 29,000 Utilities expense
8 12.28.13 12-234 Merchandise shipped FOB destination,
12.24.13; received, 1.2.14 111,500 Inventory
9 01.02.14 01-001 Legal services, received 12.28.13 46,000 Legal and professional expense 10 01.02.14 01-002 Medical services for employees for
December 2013 25,000 Medical expense
11 01.05.14 01-003 Merchandise shipped FOB shipping point,
12.29.13; received, 1.4.14 55,000 Inventory
12 01.10.14 01-004 Payroll, 12.21.13 to 01.05.14
(12 working days in total, 4 working days in January)
72,000 Salaries and wages
13 01.10.14 01-005 Merchandise shipped FOB shipping point,
1.2.14; received, 1.5.14 64,000 Inventory
14 01.12.14 01-006 Manufacturing royalties, Dec. 2013 39,000 Manufacturing costs
15 01.12.14 01-007 Merchandise shipped FOB destination,
1.3.14; received, 1.10.14 38,000 Inventory
16 01.13.14 01-008 Maintenance services, received 1.9.14 9,000 Repairs and maintenance
17 01.14.14 01-009 Interest on bank loan, 10.12.13 to 1.10.14 30,000 Interest expense 18 01.15.14 01-010 Manufacturing equipment, installed on
12.29.13 254,000 Machinery and equipment
19 01.15.14 01-011 Dividends declared, 12.15.13 160,000 Dividends payable
Accrued liabilities as of December 31, 2013 were as follows:
Accrued payroll 48,000
Accrued interest payable 26,667
Dividends payable 160,000
Accrued royalties payable 39,000
The Accrued payroll, Accrued interest payable, and Accrued royalties payable accounts were reversed on January 1, 2014. Required:
Prepare adjusting entries as of December 31, 2013 based on your review of the data given above.
Problem 3: Current Liabilities
Mix Corporation began operations in January 2012. During the course of your audit, the following information was gathered in relation to its Mix’s various product lines and segments:
Segment A
The company sells colored televisions with a brand name “TIBAYTO” that carry a two-year warranty. Management projects that 3% of the televisions will require repairs in the first year and 8% in the second year at an average cost of P5,000 per television. The television sell for P45,000.
Sales and warranty repairs for 2012 and 2013 are recorded as follows:
2012 2013
Televisions sold 250 290
Actual warranty repairs P96,000 P105,500
Segment B
You learned that in order to promote the company’s new product, the company offered a special promo by giving out a special gift to each customer who returns 10 wrappers of their new customer item plus a remittance of P15. The company estimates that out of the 250,000 units of the new product sold in 2013, 75% of the wrappers will be redeemed. In addition, you were able to gather the following information for 2013:
Special gifts purchased by Segment B 20,000 units P 560,000 Special gifts distributed to customers 7,000 units
Segment C
The company sells its products in expensive, reusable containers. The customer is charged a deposit for each container delivered and receives a refund for each container returned within two years after the year of delivery. The company accounts for the containers not refunded within the time limit was being sold at the deposit amount. Information for 2013 is as follows:
Containers held by customers at December 31, 2012,
From deliveries in: 2011 P50,000
2012 240,000 P290,000
Containers delivered in 2013 420,000
Containers returned in 2013 from deliveries in: 2011 P23,500
2012 140,000
2013 157,000 320,500
Other information was also disclosed during your audit:
Mix Corporation provides an incentive compensation plan under which its President is to receive a bonus equal to 10% of Mix’s income in excess of P100,000 before deducting income taxes but after deducting the bonus. The adjusted net income before income taxes and the bonus is P320,000.
In the middle of 2013, Mix became involved in a litigation. The suit being contested, but Mix’s lawyer believes that it is possible that Mix may be held liable for damages estimated in the range between P2,000,000 and P3,000,000, and no amount is a better estimate of potential liability than any other amount.
Based on the above and result of your audit, determine the following:
1. How much is the warranty expense for the year ended December 31, 2012? 2. How much is the warranty expense for the year ended December 31, 2013?
3. What is the adjusted balance of the estimated warranty liability account as of December 31, 2013?
4. What is the amount of liability that should be reported on the 2013 balance sheet in connection with the premium offer? 5. What is the amount of premium expense that should be reported on the income statement for the year ended 2013? 6. How much revenue from container sales should be recognized in 2013?
7. What is the total amount of liability for returnable containers at December 31, 2013? 8. What is the amount of the bonus for the year 2013?
Problem 4: Current Liabilities
BROKEN COMPANY was incorporated on February 14, 2013. It promotes quality service by engaging in repairs and reconditioning of broken machineries at an affordable price. During your audit of its liabilities account, the following transactions relevant to your examination for the year ended 2013 were gathered as follow:
Notes Refinancing
On December 31, 2013, BROKEN Co. has P4,000,000 of short-term notes payable due on February 28, 2014. On December 23, 2013, BROKEN arranged a line of credit with CUPID Bank which allows BROKEN to borrow up to P3,500,000 at one percent above the prime rate for three years. On February 2, 2014, BROKEN borrowed P2,500,000 from CUPID Bank and used P500,000 additional cash to liquidate P3,000,000 of the short-term notes payable. The statement of financial position was issued on March 15, 2014.
Compensated Absences
BROKEN gives each of its 50 employees 12 days of vacation a year if they are employed at the end of the year. The vacation accumulates and may be taken starting January 1 of the next year. The employees work 8 hours per day. In 2012, they made P14 per hour and in 2013 they made P16 per hour. During 2013, they took an average of 9 days of vacation each. The company’s policy is to record the liability existing at the end of each year at the wage rate for that year. No employees left during the two-year period.
Gift Certificates
BROKEN Company sells gift certificates, redeemable for store merchandise that expires one year after their issuance. BROKEN has the following information pertaining to its gift certificate sales and redemptions:
Unredeemed at 12/31/2012 750,000
2013 sales 2,500,000
2013 redemptions of prior year sales 250,000
2013 redemptions of current year sales 1,750,000
BROKEN's experience indicates that 10% of gift certificates sold will not be redeemed. Requirement:
Determine the amount of current liabilities to be reported at December 31, 2013. Problem 5: Bond Issuance and Retirement
In the course of your initial examination of the accounts of HIRAP CORPORATION, you obtain the following information related to the company’s bonds payable as of December 31, 2014:
Bonds Payable 03/31/2013 CR P 800,000 Treasury Bonds 10/01/2014 CD P 109,000 Bond Premium 03/31/2013 CR P 59,306
Bond Interest Expense
01/01/2014 CD P 48,000
07/01/2014 CD 42,000
The following information was noted during the course of your audit:
On March 31, 2013, HIRAP Corporation issued 800 of its 12%, P1,000 bonds. The bonds are dated January 1, 2013 with a term of 5 years and pays interest every January 1 and July 1. The effective rate on the date of issuance was 10%
The treasury bonds were acquired at a price of 106 plus accrued interest. The treasury bonds are not to be reissued. Based on the above information and result of your audit, determine the following: (Round off present value factors to four decimal places)
1. Total proceeds from bond issuance on March 31, 2013
2. Carrying value of the bonds at the end of December 31, 2013 and 2014 3. Bond interest expense for the year 2014
4. The gain or loss on partial redemption of bonds Problem 6: Compound Financial Instrument
During your audit of RELAX CORPORATION’s bonds payable account, you have noted the following transactions that took place during the year 2013:
RELAX Corporation issued 5,000 of its 10% P1,000 face amount, 10-year bonds on January 2, 2013 for P5,100,000. Each bond carries five detachable stock purchase warrants, each of which entitles the holder to purchase one ordinary share of RELAX Corporation with a par value of P25 for P60. On that date, the bonds yield at a rate of 12% while the market prices of the company’s ordinary share and warrant were P50 and P5, respectively.
RELAX issued 2,000 of its P1,000 of its 8%, 5-year convertible bonds on March 31, 2013 at 102. The bond pays interest every April 1. Each bond is convertible into two ordinary shares of RELAX Corporation. The effective rate of the bond is 10%. On June 30, 2013, 2,000 holders of bonds issued at the beginning of the year exercised their warrants. The corresponding
shares were issued on July 2. On the same date, shares of RELAX were selling at P85 per share.
On December 29, 2013, half of the bonds issued on March were converted into ordinary shares. The fair value of RELAX’s ordinary share at the end of the year was P90 per share.
The remaining warrants were no longer exercised by the bondholders at the end of the year. No entry was made by the company to account for the expired warrants.
Based on the above and result of your audit, answer the following:
1. How much of the proceeds from bonds issued will be allocated to equity? 2. How much is the carrying value of the bonds payable on December 31, 2013?
3. How much should be credited to additional paid in capital account resulting to exercise of warrants on June 30, 2013? 4. How much will total shareholders’ equity increase as a result of bond conversion?
Problem 7: Lease Liability
YEHEY Company leased equipment from YUHOO Company on January 1, 2013 under a lease with the following pertinent information: Annual rental payable at the end of each year 500,000
Lease term 8 years
Useful life of equipment 10 years
Implicit interest rate 12%
YEHEY Company has the option to purchase the equipment on January 1, 2021 by paying P400,000 which is significantly less than the expected fair value of the equipment on the option exercise date. There is reasonable certainty that YEHEY Company shall exercise the option. On January 1, 2013, YEHEY Company incurred initial direct cost of P300,000 and the fair value of the equipment is P3,000,000.
Based on the above information, determine the following: 1. Initial cost of the equipment on January 1, 2013 2. Lease liability to be recognized on January 1, 2013
3. Carrying value of the lease liability on December 31, 2013 (determine how much should be presented as current and non-current)
