Audit Practice

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OUTLINE
1. Introduction
1.1 Sources of Cash and Cash Equivalents
1.2 The Auditor’s Objective in the Audit of Cash and Cash Equivalents
1.3 How much Audit time for Cash and Cash Equivalents?
1.4 Internal Control over Cash Transactions
1.5 Summary of Functions of Departments in the Receipt Cycle
1.6 General Guidelines for Good Handling of Cash
1.7 General Pattern of Work performed by the Auditors in the Audit of Cash and Cash Equivalents
2. Primary Substantive Procedures

2.1 Sending Confirmation to banks or Financial Institutions
2.2 Obtaining and Testing Bank Reconciliation
2.3 Obtain Bank/Cash Cut-off Statement
2.4 Cash Valuation
2.5 Analyze Bank Transfers
3. Other Substantive Procedures

3.1 Surprise Cash Count
3.2 Obtain Analysis of Cash Balance and Reconcile it in the Ledger
3.3 Review Bank Statements and Bank Replies to Confirmation Letters
3.4 Verify Existence of Cash in Bank under receivership, cash in foreign banks or in foreign currency
3.5 Investigate any Large or Unusual Payments to Related Parties
3.6 Evaluate Proper Financial Statement Presentations and Disclosures of Cash
4. Situational Problems
4.1 ABC Co. - Lapping
4.2 Missing Petty Cash
4.3 Kitchen’s Inc. - Kiting
4.4 Truth Inc. - Falsification of Accounts
4.5 Management Fraud
5. Problem Solving
5.1 Bank Reconciliation
5.2 Bank Reconciliation
5.3 Petty Cash, Bank Reconciliation
5.4 Reconciliation- Collection, Deduction, Transfer
5.5 Proof of Cash
5.6 Cash Shortage
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AUDIT OF CASH AND CASH EQUIVALENTS
Sources of Cash and Cash Equivalents
Cash normally includes general, payroll, petty cash and less frequently, savings account. General Accounts
are checking accounts similar in nature to those maintained by individuals. Cash sales and collection of account
receivables typically increase the account while business expenditures decrease it. Payroll fund is used for the payment
of salaries and wages of employees of a company. Petty cash, used for very small expenditures, is replenished as
necessary.
Cash equivalents include, money market funds, certificates of deposit and other similar types of deposits. Any
items that cannot be converted into cash on short notice should be classified as either, receivable, investment, prepaid
expenses but not as a cash equivalent.
The Auditor’s Objective in the Audit of Cash and Cash Equivalents
1. Use the understanding of the client and its environment to consider inherent risk, including fraud risk related
to cash and cash equivalent.
2. Obtain an understanding of internal control.
3. Assess the risk of material misstatements of cash and design test of controls and substantive procedures that:
 Substantiate the existence of recorded cash and the occurrence of cash transactions.
 Determine the accuracy of cash transactions.
 Establish the completeness of recorded cash.
 Verify the cutoff of cash transactions.
 Determine that the client has rights to recorded cash.
 Determine that the presentation and disclosure of cash and cash equivalents are appropriate.
How much Audit time for Cash and Cash Equivalents?
The consideration of materiality applies to audit work of cash and cash equivalents. Thus, auditors do devote
a large proportion of total hours of audit to cash and cash equivalent for some reasons such as:
1. Liabilities, revenues, expenses and most other assets flow through cash transactions.
2. Cash is the most liquid of assets and it offers the greatest temptation for theft and embezzlement.
Internal Control over Cash Transactions
Most processes related to cash handling are responsibilities of the Finance Department under the direction of
Treasury. These processes include, handling and depositing cash receipts, signing checks, investing idle cash and
maintaining custody of cash and other marketable securities.
Ideally, the functions of the Finance Department and the Accounting Department should be integrated in a
manner that provides assurance that:
1. All cash that should have been received was in fact received, recorded accurately and deposited promptly.
2. Cash Disbursement have been made for authorized purposes only and have been properly recorded.
3. Cash balances are maintained at adequate levels by forecasting expected cash receipts and payments related
to normal operations.
Summary of Functions of Departments in the Receipt Cycle:
Collections.
A. Mail room or Receptionist
 Receives remittance advises and customer checks from customers
 Prepares list of receipts
 Endorses checks and list of receipts to the treasury department
 Endorses remittance advices and list of receipts to the accounts receivable department
B. Treasury Department
 Updates cash records
 Prepares deposit slips
 Prepares cash summaries, sends copy to Accounts Receivable and General Accounting, and
retains copy.
 Deposits cash collection to bank.
C. Accounting Department
 Compares remittance advice from mail room and cash summaries from treasury, updates
subsidiary ledgers, and prepares daily summaries to be forwarded to general accounting.
 Compares daily summaries from treasury and accounts receivable, then, updates General Ledger.
General Guidelines for Good Handling of Cash

A detailed study of the business processes of the client is necessary in developing the most efficient control
procedures and here the guidelines:
1. Do not permit any one employee to handle a transaction from beginning to end.
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2. Separate cash handling from record keeping.
3. Record cash receipts on a timely basis.
4. Encourage customers to obtain receipts and observe cash register totals.
5. Deposit cash receipts daily.
6. Make all disbursements by check an electronic fund transfer, with the exception of small expenditures from
petty cash.
General Pattern of Work performed by the Auditors in the Audit of Cash and Cash Equivalents
The following steps indicate the general pattern work performed by the auditors in the audit of cash and cash equivalent.
Selection of the most appropriate audit procedures for a particular audit will be guided by the nature of the controls that
have been implemented and by the results of auditor’s risk assessment process.
1. Use the understanding of the client and its environment to consider inherent risk, including fraud risk related
to cash and cash equivalent.
Risk of material misstatement arise jointly from inherent risk and control risk. Most inherent risk relates to
business risk faced by the client’s management. In the area of cash and cash equivalent, management is
particularly concerned with the business risk related to the possible theft of liquid assets. It is also a significant
concern of auditors as most misstatements of assets involve overstatements.
Concerning about the shortage of cash, a shortage may have been concealed merely by the insertion of
fictitious check in the cash on hand at year end or omission of outstanding check from year-end bank reconciliation.
Take note that this may be an indication that there is either a fraud or error.
Example 1:
Poor internal control may result in a situation in which human error resulted in the check not being recorded
in the disbursements, hence overstating cash. In other cases, the manner that the client collects cash may
present significant business and inherent risk.
Example 2:
A charitable organization may receive a large amount of fund from cash donation, creating a significant
inherent risk that not all cash donations may be received and recorded.
2. Obtain an understanding of internal control.
In the audit of a small business, the auditors may prepare a written description of the controls based upon the
questioning of owners and employees and upon firsthand observation. In a larger company, a flowchart or internal
questionnaire for cash disbursement is usually employed to describe internal control.
After the auditors have prepared the flowchart and other description, they will conduct a walkthrough of the
system. Walk-through means to trace a few transactions through each step of the system to determine the
transactions are actually being processed in the manner indicated in the flowchart.
Walkthrough allows the auditor to determine that internal controls describe in the working paper has actually
been implemented.
3. Assess the risk of material misstatements and design further audit procedures.
After obtaining an understanding of the client’s internal control over cash, the auditors determine their planned
assess levels of risk of material misstatement for the assertions about cash. If additional evidence of effectiveness
of the cash is needed to support the assessed levels, the auditors will design additional test of control.
Description of Misstatement
1. Failure to record cash from collection of Fraud
accounts receivable. A bookkeeper who has access to cash receipts
embezzles cash collected from customers and write off
the related receivables.
2. Inaccurate recording of a purchase Error
disbursement. A disbursement is made to pay an invoice for goods
that have not been received.
Once these risks of material misstatement have been identified and assessed, the auditors can plan
appropriate substantive procedures that address them.
4. Perform Further Audit Procedures – Test of Control
Example:
To determine that client’s accounting procedures are operating effectively, the auditors perform test of
accuracy of client’s journals and ledgers.
 In a computer-based system, journal and ledger entries maybe created simultaneously from the
same source of document and the auditors may choose to use Computer Assisted Audit
Techniques to test the accuracy of client’s accounting procedures.
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 In a manual system, the information from source document is entered in the journal, at a later date
the information is summarized and posted from journals to ledgers. The auditor must manually
determine that documents are accurately entered into the journals, journals are accurately footed
and the data are properly posted to the ledgers.
PRIMARY SUBSTANTIVE PROCEDURES

1. Sending confirmation to banks or financial institutions
One way that the auditor can verify the amount of cash is by sending confirmation to banks or financial institution.
The auditor can confirm the amount of deposits in the bank or financial institution by sending a standard confirmation
letter or request which will help in determining the gross valuation of the cash in bank. Form sent is primarily used to
corroborate existence of recorded information and discovery of additional accounts or loans. It will let the auditor know
basically if the cash amount presented or provided by the client really exist or if some of accounts are omitted meaning
search for undisclosed liabilities and commitments.
On the other hand, in determining if there is a need for a bank account to be confirm there is no need to consider
its amount or materiality. Instead other factors can be looked in to such as the volume of transactions passing through
an account, example of this accounts are main accounts used in the trading operation of the entity or the purpose of
an account.
Bank Confirmations should be prepared and signed by the client, mailed by the auditor and should be received
only by the auditor. There is no need for the client to receive this confirmation. We are all aware that an evidence that
came from a third party or outside party of the entity will be classified as a high type of evidence, thus directly being
sent to the auditor is making it as one.
The details of other financial arrangements are also confirmed with financial institutions. A separate confirmation
request should be sent to the individual in the financial institution who is responsible for the financial arrangement or to
the person knowledgeable about it.
A bank confirmation letter is a letter from a bank or financial institution confirming the existence of a loan or a line
of credit that has been extended to a borrower.
 The procedure fulfilled the assertions of:
 Existence
 Valuation
 Rights and obligations
 Presentation and Disclosure
(Note: An example of a Bank Confirmation Letter is presented on the succeeding page.)
2. Obtaining and testing bank reconciliation
In determining the cash position as of year-end requires a reconciliation of the information on the bank statement
and accounting record. The auditor should test this reconciliation to know if the cash position is as presented.
A bank reconciliation is the process of matching the balances of entity’s accounting records as to cash account
with the corresponding information in the bank statement.
After the auditor make his own bank reconciliation the auditor should:
1. Verify the cash balance in the bank reconciliation by tracing balances to the bank statement and ledger
account. The auditor can inspect the cash balances by tracing the balance per bank in the ledger, the cash
disbursement and cash receipts journal. Also, you can verify by tracing the balance per bank in the bank
statement, bank confirmation, and bank cut-off statement.
2. Check the accuracy of footings in the bank reconciliation;
3. Investigating the reconciling items.
What are these reconciling items?
These are the items which will reconcile the balance per bank and balance per book into equal amount.
Common examples for bank reconciling items are deposit in transits and outstanding checks which can be
mostly found in the bank cut-off statement and for the book reconciling items are the notes received by the
bank and bank charges which can be found in the bank statement.
It is very important to carefully review the bank reconciliation because the client might conceal a cash
shortage by omitting an outstanding check on the list or purposely make an error in adding in the
reconciliation.
 Existence
 Completeness
 Valuation
 Rights
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Example of a Bank Confirmation Letter
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3. Obtain cash/bank cut-off statement
 Cash Cut-off Test
The auditor should perform cash cutoff test procedures on cash receipts, disbursement and transfers to
determine if these transactions are reflected in the proper period. This is being done to avoid window dressing.
When testing cutoff of cash receipts and cash disbursements at the reporting date, audit procedure might
include:
o Comparing deposits on the bank statements immediately before and after the reporting period date
with entries in the cash receipts journal to establish the reasonableness of the deposit in transit at
the reporting date; and
o Comparing the dates of the disbursement and receipt of intercompany payments or interbank
transfers immediately before and after the reporting date to establish that both receipts and
disbursements were recorded in the proper periods.
 Bank Cut-off Statement
Bank cut-off statement a statement from the bank covering a specified number of business days (usually 7-
10 days) following the end of the clients reporting date. It’s like a normal bank statement that contains the
transactions clearing from the last bank reconciliation, the only difference from a normal bank statement is the
span of time is from 7-10 days only.
So how to obtain a bank cut-off statement? The client will have to ask for a bank cut-off statement and then
should be mailed directly to the auditor.
Upon receipt, the auditor should:
a. Trace all prior year dated checks to the outstanding checks listed on the bank reconciliation
b. Trace deposit in transit on the bank reconciliation to deposits on the cut-off statement
c. Scan the cut-off statement and enclosed data for any unusual items
This is how an auditor should check the accuracy of the of the items. From the date of the last bank
reconciliation the outstanding checks and deposits in transit should clear the in the 7-10 day span of time. This
bank cut-off statement provides assurance that the amount of cash shown on the balance sheet was not
overstated by the omission of one or more checks from the list of checks outstanding.
 Completeness
 Existence
4. Cash valuation
Some companies may maintain its bank account in foreign countries for some business purposes. If the bank being
reconciled is in a foreign currency, the auditor should test the conversion of cash balance to the presentation currency
to determine whether cash is stated at its realizable value.
The auditor ordinarily should:
1. Obtain the period-end foreign exchange rate from an independent source;
2. Re-perform the conversion of cash balance into the currency using this rate; and
3. Compare the resultant amount to the balance in the general ledger and accounting for any differences.
The auditor should identify the bank accounts that exist, understand their purpose and determine the monetary
volume of transactions flowing through them. When tailoring an audit program consider and design audit procedures
that address relevant presentation and disclosure requirements.
Since we already know what a bank reconciliation is, we should also know that an auditor should test the accuracy
of the items of the year end reconciliation of the entity’s bank account. So for the auditor to find out he/she should
obtain a bank cut-off statement.
 Valuation
5. Analyze bank transfers
In maintaining one or more checking accounts, some finds it necessary for them to transfer from one bank account
to another. As a result, the auditor should do the last procedure which is to analyze their clients’ bank transfers. The
purpose of this is to disclose the overstatement of cash balances resulting from kiting.
Kiting is when bank withdraws money from an account and deposits in to another, several days passes before that
withdrawal clears from that bank account. From that moment nothing was deducted from the account where the deposit
came from. During that period which is also called the float period that amount of check withdrawn are included in both
banks. This where kiting could take place. Kiting is the manipulation that utilizes temporarily overstated bank accounts
to conceal cash shortage or for to meet short term cash needs. Auditors can detect this manipulation by preparing a
schedule of bank transfers for a few days before and after the balance sheet date. This bank transfers lists all bank
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transfers and shows the dates that the receipts and disbursements of cash were recorded in the cash journal and on
the bank statements.
So, this is how it works: A schedule is shown and by comparing the dates on the schedule of bank transfers, auditor
can determine whether any manipulations of cash balance have taken place.
The increase in one bank account and decrease in the other bank account should be recorded in the same
accounting period.
As you can see in the illustration that CHECK NO 6006 was recorded in the cash journal as a receipt on Dec. 30
and a disbursement of January as a result cash is overstated on December 31. So, for the cash receipts to be in
balance, some account must have been credited on December 30 to offset the debit to Cash.
 Completeness
 Existence
 Rights
OTHER SUBSTANTIVE PROCEDURES
1. Surprise cash count

Cash on hand ordinarily consist of undeposited cash receipts, petty cash funds and change funds. Cash count can
be conducted before or after the reporting date.
The auditor should plan to count all cash and should consider the following:
1. Surprise cash count
2. Control all cash funds
3. Count in the presence of custodian
4. List each item in the fund showing the denominations of notes and coins
5. The custodian should sign the record as evidence of the return of funds and
6. Agree the total to the cash book balance and investigate differences.
 Existence
 Valuation
 Rights
2. Obtain analysis of cash balance & reconcile it in the ledger

Schedule will typically list the bank, account number, account type whether current, savings or time deposit and
the year-end balance per books. Auditor will trace and reconcile all accounts to the general ledger.
 Existence
3. Review bank statements and bank replies to confirmation letters

A need to review any bank overdrafts and note the existence of any funds that may be subject to withdrawal
restrictions in order to determine the effects on financial statement presentation. Bank overdrafts arises when bank
balances are overdrawn meaning the bank balance is negative. Bank overdrafts should not be netted to other bank
accounts with positive balances unless it is part of the policy of the management or the amount is immaterial. Bank
overdrafts are reported as current liabilities.
 Rights and obligations
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4. Verify existence of cash in bank under receivership, cash in foreign banks or in foreign currency
Can be done by examination of minutes of meetings, loan agreements, and confirmations.
 Valuation
5. Investigate any checks representing large or unusual payments to related parties
Carefully reviewing any large or unusual checks payable to directors, officers, employee, affiliated companies, or
to cash by the auditors to determine whether the transactions were properly authorized and recorded and are
adequately disclosed in the financial statements. To provide assurance that cash disbursements of transactions with
related parties were authorized transactions and properly recorded, the auditors should determine that each transaction
has been charged to proper account, is supported by adequate vouchers or other documents, and was specifically
approved in advance by an officer other than the one receiving the funds.
 Presentation and disclosure
6. Evaluate proper financial statement presentations and disclosures of cash
The cash in bank and cash on hand should be presented in the financial position in a single account. The bank
deposits that is restricted in use should not be included in cash. (ex. Cash deposited with a trustee for payments on
long term debts.) And the agreements to compensating balance should be disclosed. Compensating balance only refers
to a client’s agreement with a bank to maintain a specified minimum amount in checking account. This compensating
balance are often required under the terms of a bank loan agreement.
 Presentation and disclosure
“One essential thing an auditor must have all throughout the audit engagement is his professional skepticism.”
SITUATIONAL PROBLEMS
SITUATIONAL PROBLEM NO. 1 – ABC Co. (Lapping) .

Outline of the case:
Central Perk is a small grocery store located in F. Tanedo St. and has been in the industry for 5 yrs. ABC Co.
is also supplying some sari-sari stores from barangays in Tarlac City.
Joey, a bookkeeper of ABC Co. for 3 years has been nothing but a good employee believing that doing good
things will lead you to a good life. He is in charge for receiving checks and cash and communicating it with the AR
Accountant, Miss Pheebs, which will then prepare the money for deposit. The Company’s accounting policy
regarding Accounts Receivable is 2/15, n/30. Joey has earned the good trust of the company.
The CFO of ABC Co. has resigned and leaving the position vacant. ABC Co. hired new personnel, Ross, to
fill in the vacant position and the new personnel hired was the son of the Chairman’s friend. Due to this, the AR
accountant resigned as a sign of protest and ABC Company entrusted Math with the work for the mean time.
November 20, 2019, Joey, on his way home has been pickpocketed. As he arrived home, he noticed that
there was wallet was missing. The money is supposed to be his payment for his rent that is due on the end of the
month. He was devastated. Joey, on the next day asked the CFO to raise his salary since his been doing two jobs.
The CFO said that his request will only push through next year and wish him luck. Joey is occupied the whole day
thinking how he will survive this challenge.
November 27, 2019. His landlord reminded him of the rent before he leaves for work. His so angry to himself
for living that way and angry at life, in general. He continues doing his work until suddenly it hit him of what he can
possibly do with this crisis happening to him. In his mind he’s thinking of stealing some cash to pay his dues. That
day, Customer Brie paid her credit with an amount of Php19,600 because she has been able to pay within 15 days
allowing her to have a 2% discount. Math can’t help himself and gave in with the temptation. Joey paid his landlord
that day. The next day, Customer Jaq paid Php39,200 twenty (20) days after. What Math did is, he took Php19,600
out of the Php30,250 to pay Customer Brie’s credit and make it seem like Customer Jaq only paid half. He also
prepared the Original Receipts for all paid credits. Math broke his principle and been doing the same thing again
and again.
Come audit season, the auditor named Chandler, had ask for the assertions of the company and spot the
difference between the Subsidiary ledger and the General Ledger. The Auditor asked the CFO regarding this
situation and said, “Our reliable employee has been doing two works at the same time and with that some vouchers
aren’t still being accounted.”
Chandler wasn’t satisfied with the CFO’s answer and did a walk-through test of himself. He learnt the
company’s internal control and see that due to cost-cutting the Company let Math do the work at the same time.
He also asked for the company to send letters to its customers indicating of what do they owe and if it is right and
communicate their reply with him.
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To Chandler’s luck, a week after the letters were sent, two sari-sari store owners replied. One customer replied
that what was sent to him was right and the other customer named Mon replied furiously stating that he paid
already and told the company to do their job right. With that, Chandler searched for the records of Customer Mon
and the records said that she didn’t pay yet. He communicated it with Ms. Rach, his supervisor. Ms. Rach had
talked about this with the company and confirmed that Math has been stealing cash to their client and commend
Ace for a job well done.
*If no customer replied, an Auditor can match the OR receipts from Invoice Receipts prepare by the Sales
Department.
Discussions of the case:
SUBSTANTIVE AUDIT PROCEDURES WHEN THERE IS AN INDICATION OF LAPPING:
1. Confirmation of accounts receivable. Just as is done in the audit of accounts receivable, the auditor
should consider the amount of deposits that contain a large number of doubts. Send letters to
customers regarding their credits.
2. Doing the calculation of cash suddenly. The calculation of the amount of money in the company should
be done suddenly, with the intention that lapper cannot prepare for the possibility of fraud known to the
auditor. Given the element of surprise, deception posed insurmountable.
3. Perform daily cash receipts journal comparisons with corresponding daily deposit slip details
SITUATIONAL PROBLEM NO. 2 – Joey (Missing Petty Cash) )

Joey, the petty cash custodian has always been the breadwinner of his family. He is the oldest among his 4
siblings and his father died when he was young. His mother can’t work anymore due to her age. He has been
bringing postage receipts from home and paid them from the fund, he persuaded his supervisor, Marshall, to sign
blank authorization slips that he could use when Marshall is away and used them to pay for fictitious meals and
minor supplies. Postage receipts were from a distant post office station the company did not use. The blank
authorization slips were dated on day Marshall was absent. The fund was cash short during the weekend and for
a few days flowing the week. The fund was small ($500), but Joey replenished it about every two working days,
stealing about $59 each time. With about 260 working days per year and 130 reimbursements, Joey was stealing
$6,500 per year.
The audit team found out of this scheme Joey has been doing. During the audit engagement, the auditor in
charge for cash, Ted has done some petty cash count when suddenly he saw the postage receipts which came
from an unknown post office. He searched the location of the post-office and found out that it was near to Joey’s
house. That resulted to her thinking of Joey doing some anomalous things. The next day, in the afternoon Ted did
a surprise cash count. To his count, the fund was short of $65 and that conceded the scheme Joey has been doing.
SUBSTANTIVE AUDIT PROCEDURES OF PETTY CASH FUND:
1. Have a meeting with the petty cash custodian.
2. Do a cash count on currencies and coins. Also, count the value of postage stamps or negotiable
instruments (like traveler's checks or bonds) stored with the petty cash.
3. Sum all the vouchers and receipts used to justify payments from petty cash or records of transactions
adding to the cash.
(Note: Make sure that all the documentation is legitimate and conforms to any applicable reimbursement or
expenditure policies.)
4. Add the cash total to the voucher total.
5. Inspect the place that the petty cash is stored. Ensure that access is restricted to the custodian or to
people who have legitimate access to the cash box.
SITUATIONAL PROBLEM NO. 3 – Kitchens Inc. (Kiting) .

The Kitchens Inc is a giant in the food industry. The company specializes in culinary ingredients which are
bought by expert chefs and restaurants around the world. Over the span of ten years, since 2009, the company
has gradually earned its name and established a good working relationship with financial institutions. This is due
to the unrelenting efforts and dedication of the brilliant CEO of the company.
Reginald Hargreeves, an eccentric man, who in his childhood was told to do everything to reach a goal until
all resources are consumed in all possible manners. Under the supervision of Hargreeves are the four managers,
Allison Spara, the finance manager, Ben Mouri, the marketing manager, Luther Bertrand, the production manager
and Vanya Dilallo, the personnel manager.
An audit during 2019 is conducted, Mr. Hargreeves is not present and will be gone for a month because of
negotiations abroad. Now everything is going according to the audit plan, however, suddenly, finance manager
Allison Spara disclosed something but hesitantly.
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From her sudden testimony some indications of an unlawful act are disclosed:
 There are 13 undisclosed bank accounts under the common control of the chief executive officer.
 High percentage of daily deposits are coming from these accounts.
 Checks are drawn and deposited from these accounts despite having insufficient funds.
 At the same time, funds are taken account from the other account where the checks are deposited.
 It is a practice that the department has been told to do by the CEO which is happening for several years
now.
Gathering more evidence, inquiries are made to different managers. At the factory, Luther Bertrand, when he
is asked about problems they have dealt with these past years, discusses how the global epidemic of animal
diseases and frequent wildfires that started since 2012 which destroyed more than half of their resources affected
the operations. The lack of resources caused the prices going up. The company needed a large sum of funds to
aid the production of goods.
As for Ben Mouri, the marketing manager, whose quiet nature sends innocence, has only discussed the annual
sales of the company which only supported what the production manager said. There was a significant change in
the sales of the company, it quickly decreased from 2012 until the year 2015.
Now, the personnel manager, Vanya Dilallo seems like harmless, she is rather the normal employee whose
one true strength is honesty. She is asked how the hiring goes, and even now, the CEO troubles himself to interview
the applicants. Sometimes the CEO is the one who just introduces and hires a new employee after a former
employee is terminated by none other than the CEO. This happens every year. Discuss the possible approach the
auditor may perform with in this situation.
This is check kiting. Check kiting is a sophisticated scheme. It is sometimes hard to prove due to its complexity.
But there are some suggested solutions that the auditor can use:
 It is advisable to cooperate with the financial institutions especially there is a great number of accounts
used in the scheme. This scheme can be very difficult to track because most of the time the money can
only be proven to be nonexistent when the company stops the kiting process, or the bank is alert and
picks up on the scheme before it generates more damages and losses.
 Prepare a bank transfer schedule. This allows the auditor to track the transfer of funds from several
bank accounts to another bank account of the client or company. It can show if the disbursement from
a bank account was recorded at the time of deposit to another bank account in the books.
 Obtain a bank cut-off statements. By using these statements, the auditor can trace the prior-period
outstanding checks that has been cleared in the next period. If there is a check that has been cleared
but not included in the outstanding checks, there is kiting.
SITUATIONAL PROBLEM NO. 4 – Truth Inc. (Falsification of Accounts) .

The Truth Inc. is a massive IT company, fourth largest in the country.
In January 2009, the chairman of the board sends a letter that starts “With deep regret and tremendous burden
that I am carrying on my conscience1” and goes on to say that the company’s balance sheet carries inflated cash
of more than $1 billion, $77 million (m) of accrued interest that is nonexistent, $253m of understated liability
arranged by the chairman, and overstated receivables of $101m and that the income statement shows overstated
profits for the last several years.
The fraud was made possible despite being audited by international auditing firms and having the requisite
number of independent directors with excellent credentials due to the other board members being unaware of the
financial irregularities, the manipulation of the cash flow, and the reluctance of the shareholders and independent
directors to question the chairman which is also the company founder, including in the boarding members are from
the Koothrappali family and friends are in the senior managements. The auditors who audited the company relied
on bank statements provided by the company which turned out to be fabricated.
It was cited that the pressure to maintain the pace of growth, please investors and shareholders and justify
inflated P/E multiples during six-year Bull Run on the stock market are the reasons why Koothrappali falsified the
books.
Enumerate and discuss the auditing procedures that could have been done to discover and prevent the fraud.
This is a case of massive corporate fraud. It has a big impact not just to investors and employees of the
company where the fraud is done but also to its industry. These are what could have been done against the fraud.
 Thoroughly assess the internal control and operating effectiveness
 Verify the authenticity of the documents
 Use algorithms to help discover unusual patterns
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SITUATIONAL PROBLEM NO. 5 – Management Fraud .
Over 15-year periods, the management had falsified accounts and created assets to hide losses of $10 billion
by hiding loses and increasing assets on its balance sheet. In 2000, after 10 years, the company was forced to
change auditors. In 2002, an audit was conducted and the auditors missed red flags. A confirmation from the bank
was received through fax transmission which verified the existence of the bank account with $4.9 billion balance.
It was a forgery. The facsimile was smudged, and the auditors missed the subtle and obvious red flags. However,
during 2003, the company defaulted on bond payment of $187 million despite having a 4.9 billion cash balance.
This alerted the auditors and the regulators. In the initial investigation, it was estimated that $19 billion of assets
were nonexistent or missing. The company filed for bankruptcy protection.
During the on-going investigation, an employee turned over a number of incriminating disks which contained
company documents. With evidence mounting, the CEO and the founder admitted to prosecutors that they were
aware of the fraud and misappropriating assets for personal purposes. More than 30 people were charged with
fraud, embezzlement, false accounting, and misleading investors. These included executives, family members,
former employees, and even lawyers.
State the steps that should have been taken by the auditors during the 2002 audit.
 The auditor should communicate the situation to the Audit Partner.
 The Audit Partner should schedule a meeting with the Audit team to discuss possible plan regarding the case.
 The auditors should have followed up with bank followed up with the bank given the circumstances.
PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – Cordial Company .

You are conducting an audit of the Cordial Company for the year ended December 31, 2019. The internal control
procedures surrounding cash transactions were not adequate. Ethel Diaz, the bookkeeper-cashier, handles cash
receipts, mains accounting records and prepares the monthly reconciliations of the bank account.
The bookkeeper-cashier prepared the following reconciliations at the end of the year:
Balance per bank statement Php350,000.00
Add: Deposit in transit Php175,250.00
Note collected 15,000.00 190,250.00
Balance Php540,250.00
Less: outstanding checks (246,750.00)
Balance per general ledger Php293,500.00
In the process of your audit, you gathered the following:

a. At December 31, 2006, the bank statement and the general ledger showed balances of Php 350,000 and Php
293,500, respectively.
b. The cut-off bank statement showed a bank charge on January 2, 2020 for Php30,000 representing a correction
of an erroneous bank credit.
c. Included in the list of the outstanding checks were the following:
* a check payable to a supplier, dated December 29, 2019 in the amount of Php14,750, released on
January 5, 2020.
** A check representing advance payment to a supplier in the amount of Php37,210, the date which
is January 4, 2020 and released in December 2019.
d. On December 31, 2019, the company received and recorded customer’s postdated check amounting to
Php50,000.
Questions:
1. The adjusted DIT at December 31, 2019.
2. The adjusted outstanding checks as at December 31, 2019.
3. The adjusted cash to be presented in the balance sheet as at December 31, 2020.
4. Cash Shortage
5. The net adjustment to the cash account.
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Suggested Solution:
Bank Book
Unadjusted balance Php350,000.00 Php293,500.00
Add(deduct): Adjustments
Deposit in transit (175,250-50,000) 1.) 125,250.00
Postdated customer’s check recorded on 12.31.19 (50,000.00)
Note collected by bank 15,000.00
Outstanding checks (2476,750 – 14,750 -37,210) 2.) (194,790.00)
Check payable to a supplier released on Jan. 5, 14,750.00
2020
Check dated Jan. 4,200 recorded and released in 5.) (37,210)
Dec. 2019
Erroneous bank credit corrected on Jan. 2, 2020 (30,000.00)
As corrected 250,460.00 310,460.00
Unlocated difference shortage (4) (60,000.00)
Balance as adjusted Php250,460.00 (3) Php250,460.00
PRACTICAL PROBLEM NO. 1 – Wiles’ Inc .

Bob is reviewing the cash accounting of Wiles’, Inc. A local mailing service. Bob’s review will focus on the petty cash
account and the bank reconciliation for the month ended May 31, 2019. He has collected the following information from
Wiles’ bookkeeper for this task.
Petty Cash
1. The petty cash fund was established on May 10, 2019, in the amount of Php250.
2. Expenditures from the fund by the custodian as of May 31, 2019 were evidenced by approved receipts for the
following:
Postage expense Php33.00
Mailing labels and other supplies 75.00
I.O.U from employees 30.00
Shipping charges 57.45
Newspaper advertising 22.80
Miscellaneous expense 15.35
3. On May 31, 2019, the petty cash fund was replenished and increased to Php300.00; currency and coin in the
fund at that time totaled Php16.40.
Standard Bank
Bank Statement
Disbursements Receipts Balance
Balance, May 1, 2019 Php8,769.00
Deposits 28,000.00
Note payment direct from 930.00
customer (interest of
Php30.00)
Checks cleared during
May
Bank service charge 31,150.00
Balance, May 31, 2019 Php6,522.00
Wiles’ cash account

Balance, May 1, 2019 Php9,150.00
Deposits made on the month of May 31,000.00
Checks written on the month of May (31,855.00)
Deposits in transit are determined to be Php3,000 and checks outstanding at May 31 total P550. Cash on hand besides
petty cash at May 31, 2019 is Php246.
Question:
1. What amount of cash should be reported in the month ended May 31, 2019 balance sheet?
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Suggested Solution:
Balance per bank Php6,522.00
Add: Cash on hand Php246.00
Deposit in transit 3,000.00 3,246.00
Total Php9,678.00
Deduct: Checks outstanding (550.00)
Adjusted bank balance Php9,218.00
Balance per books Php8,315.00

Add: Note collected 930.00
Total Php9,245.00
Deduct: Bank service charge (27.00)
Adjusted cash balance Php9,218.00
1.) Cash should be: Php9,218 + 300= Php9,518
PRACTICAL PROBLEM NO. 3 – Posh Inc. .

Presented below is information related to Posh Inc.
Balance per books at October 31, 2019 Php41,847.85
Receipts 173,523.91
Disbursements 166,193.54
Balance per bank statement, November 30 56,274.20
The following checks were outstanding at November 30:
1224 Php1,635.29
1230 2,468.30
1232 3,625.15
1233 482.17
Included with the November bank statement and not recorded by the company were a bank debit memo for Php27.40
covering a bank service charges for the month, a debit memo for Php572.13 for a customer’s check returned and
marked as NSF and a credit memo for Php1,400 representing bond interest collected by the bank in the name of Posh
Inc. Cash on hand at November 30 recorded and awaiting deposit amounted to Php1915.40.
Question:
1. The adjusted cash balance as at November 30, 2019 is?
2. The unadjusted book balance is?
Suggested Solution:
Posh Inc.
Bank Reconciliation
November 30, 2019
Balance per bank statement, Nov. Php56,274.00
30
Add: Cash on hand, not deposited 1,915.40
Deduct: Outstanding checks (8,210.91)
#1224 Php1,635.29
#1230 2,468.30
#1232 3,625.15
#1233 482.17
1.) Correct cash balance Php49,978.69
Balance per books, October 31 Php41,847.85

Add: receipts for November 173,523.91
Total Php215,371.76
Deduct: Disbursements for November (166,193.54)
2.) Unadjusted, Nov. 30 book balance Php49,178.22
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PRACTICAL PROBLEM NO. 4 – Apple Company .
Apple Company carries its checking account with Commerce Bank. The company is ready to prepare its December 31
bank reconciliation and has requested you as auditor to prepare it for them. The following data are available:
a. The November 30 bank reconciliation showed the following: (1) cash on hand (held back each day by apple
Company for change), P400(included in Apple’s Cash account); (2) deposit in transit, #51, P2,000; and (3)
checks outstanding, #121, P1,000, #130, P2,000; and #142, P3,000.
b. Apple Company Cash account for December:
Balance, Dec 1 Php64,000.00
Add: Deposits
#52 -
#55 Php186,500.00
#56 3,500.00 190,000.00
Less: Checks
#143 -
#176 191,000.00
#177 2,500.00
#178 3,000.00
#179 1,500.00 (198,000.00)
Balance, Dec 31 (includes P400 cash held each day for change) Php56,000.00
c. Bank Statement
Bank Statement
December 31
Add: Deposits
#51 Php2,000.00
#55 186,500.00 188,500.00
Less: Checks
#130 2,000
#142 3,000.00
#143 -
#176 191,000.00 (196,000.00)
Note Collected for Apple Company (including P720 interest) 6,720.00
Fund Transfer received for foreign revenue (not yet recorded by 10,000.00
Apple Company)
NSF check, Customer Belinda (200.00)
United fund (per transfer authorization signed by Apple Co.) (50.00)
Bank service charges (20.00)
Questions:
1. Identify by number and amount the December 31 deposits in transit and checks outstanding.
2. Prepare the December 31 bank reconciliation.
3. Prepare journal entries from bank reconciliation
Suggested Solutions:
1.) Identify by number and amount the December 31 deposits in transit and checks outstanding.
a. Deposits in transit: #56 (P2,000 + 190,000 -188,500) Php3,500.00
b. Checks Outstanding:
#121, P1,000.00
#177, P2,500.00
#178, P3,000.00
#179, P1,500.00
Total P8,000.00
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2.) Prepare the December 31 bank reconciliation.
BANK BOOKS
Balance, December 1 76,550 56,000
Additions: 400
Cash on hand
Deposit in transit 3,500
Note collected
Principal 6,000
Interest 720
Funds received from foreign 10,000
revenue
Deductions: (8,000)
Checks Outstanding (#121,
#177-179)
NSF check, Customer Belinda (200)
United Fund Transfer (50)
Bank Service Charge (20)
Correct cash balance Php72,450 Php72,450
3.) Prepare journal entries from bank reconciliation
a. Cash 16,720
Note Receivable 6,000
Interest Revenue 720
Foreign Revenue 10,000
b. Account Receivable, NSF check 200

(customer Belinda)
Contributions, United Fund 50
Expense, bank service charge 20
Cash 270
PRACTICAL PROBLEM NO. 5 – October Company .

You have been asked by the proprietor of the October Company to verify the accountability of the cashier-bookkeeper,
who was allowed to take a vacation leave a few days ago.
A. The bank reconciliation statements prepared by the cashier-bookkeeper are presented below:
November 30, 1998

Cash on hand ₱ 500.00
Total ₱c Php22,000.00
Outstanding checks:
No. 2520 Php2,000.00
No. 2521 ₱1,400.00
No. 2522 ₱1,900.00 (3,300.00)
Erroneous bank charge ₱ 2,000.00
Erroneous bank credit (500)
Book balance Php 20,200.00
December 31, 1998

Cash on hand 6,300.00
Total Php141,300.00
Outstanding checks:
No. 2520 Php31,000.00
No. 2521 ₱10,300.00
No. 2522 ₱ 5,000.00 (41,300.00)
Erroneous bank charge ₱ 3,000.00
Erroneous bank credit (600.00)
Book balance Php 102,400.00
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B. The following Cash in Bank account in the general ledger shows the following debits and credits during December:
Cash in Bank
December December
1 Balance Php 20,200 1 Checks issued ₱ 2,000
2 Received from customers ₱ 4,500 5 Checks issued ₱ 5,200
23 Received from customers ₱ 9,000
27 Received from customers ₱ 70,000
31 Received from customers ₱ 48,500 31 Balance ₱ 102,400
Total Php 198,200 Total Php 198,200
C. The following summarized transactions were taken from the bank statement for the month of December 1998:
Balance, December 1, 1998 Php16,500
Total deposits Php173,700
The total deposits per bank statement include:
a. Collection of notes receivable Php5,000
b. Correction of November erroneous bank charge ₱ 2,000
c. December 10 deposit of Sunday Company credited in error to October Company ₱ 600
Total Php7,600
Total checks Php65,200

The total checks per bank statement include:
a. Correction of November erroneous bank credit Php500
b. December check of Matthew Company charged in error to October Company ₱ 3,000
Total Php7,600
D. Cash on hand per count in the morning of January 2, 1999 amounted to ₱6,300.
E. Before leaving his company for a one-week vacation, the proprietor had left several signed blank checks that the
cashier-bookkeeper had cashed for his personal use.
Questions:
1. What is the cash shortage as of November 30, 1998?
2. The amount of unaccounted receipts in December is
3. The amount of unrecorded/unsupported disbursements in December is
4. What is the total cash shortage as of December 31, 1998?
5. What is the adjusted cash balance on December 31, 1998?
November 30 Receipts Disbursements December 31
Bank balances Php 16,500 Php 173,700 Php 65,200 Php 125,000
Undeposited collections:
November 30 ₱ 500 ₱ (500)
December 31 ₱ 6,300 ₱ 6,300
Outstanding checks:
November 30 ₱ (5,300) ₱ (5,300)
December 31 ₱ 46,300 ₱ 46,300
Erroneous bank charges:
November 30 ₱ 2,000 ₱ (2,000)
December 31 ₱ (3,000) ₱ 3,000
Erroneous bank credits:
November 30 ₱ (500) ₱ (500)
December 31 . (600) . (600)
Adjusted bank balances Php 13,200 Php 176,900 Php 102,700 Php 87,400
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November 30 Receipts Disbursements December 31
Book balances Php 20,200 Php 178,000 Php 95,800 Php 102,400
Underfooting of receipts ₱ ₱ 9,000 ₱ 9,000
Overfooting of disbursements 5,000 ₱ (4,000)₱ ₱ 4,000
Bank collection ₱ 5,000
Corrected book balances 20,200 192,000 91,800 120,400

5.) Adjusted bank balances ₱ 13,200 ₱ 176,900 ₱ 102,700 ₱ 87,400
1.) Shortage as of November 30 7,000
2.) Unaccounted receipts 15,100
3.) Unsupported/unrecorded 10,900
disbursements
4.) Shortage as of December 31 \ Php 33,000
Cash receipts per ledger (₱198,200 – ₱ 20,200) Php 178,000

Total cash receipts per audit ₱ 187,000
Underfooting of cash receipts Php (9,000)
Cash disbursements per ledger (₱ 198,200 – 102,400) Php 95,800

Total cash disbursements per audit ₱ 91,800
Overfooting of cash disbursements Php 4,000
PRACTICAL PROBLEM NO. 6 – Desole Company .

The Desole Company does not have adequate controls over its cash transactions. During an audit, you found the
following data concerning its position at December 31, 2000.
 On the company’s records the cash balance is ₱173,500.

 A credit of ₱2,500 for a note collected by the bank for a note collected by the bank does not appear on the
company’s records.
 The bank statement balance is ₱135,000.
 Outstanding checks are as follows:
Number Amount
1428 Php5,200
1431 3,600
1445 4,080
1446 3,460
The cashier made the following reconciliation:

Balance per bank statement Php35,000
Deduct: Outstanding checks:
No. 1431 Php3,600
No. 1445 ₱ 4,080
No. 1446 ₱ 3,460 ₱ 10,140
Add: Undeposited collections (per

count) Php46,140
Collected note ₱ 2,500 Php48,640
Cash per books, December 31, 2000 Php 173,500
Questions:
1. What is the total shortage?
2. How did the cashier attempt to conceal the shortage?
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Book Bank
Unadjusted balances Php173,500 Php135,000
Note collected by the bank ₱ 2,500
Outstanding checks ₱ (16,340)
Undeposited collections __d ₱ 46,140
Corrected balances Php176,000 Php164,800
1.) Shortage (11,200) – -
Adjusted balances Php164,800 Php164,800
2.) Concealment of shortage:

Omission of outstanding check no. 1428 Php 5,200
Underfooting of outstanding checks in reconciliation (₱11,140 – ₱10,140) ₱ 1,000
Adding (instead of deducting) the unrecorded note collected by the bank ₱ 5,000
Total shortage Php11,200
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25 | P a g e
OUTLINE
1. Introduction
1.1 Primary Risks for Audit of Receivables and Revenues

2.1 Reconciliation of Subsidiary Ledger with General Ledger
2.2 Confirmation of Receivables and Review of Subsequent Cash Receipt
2.3 Evaluating the Adequacy of the Allowance for Doubtful Accounts
2.4 Expected Credit Loss
2.5 Accounts Receivable and Sales Cutoff
2.6 Investigate Any Transactions with or Related Party Receivables.
2.7 Analyzing Credit Balances and Unusual Items.
2.8 Ascertaining Whether Any Receivables Have been Pledged or Assigned
2.9 Performing Analytical Procedures.

3.1 Bill and Hold Transaction
3.2 Multiple Element Arrangement
3.3 Percentage of Completion Method
3.4 Sales Returns
3.5 Receivables Denominated in Foreign Currency
3.6 Analysis of Notes Receivable and Related Interest
4.1 Palisades, Inc. - Unreplied Confirmation Letter
4.2 Lakeside Company - Forbidden Communication with Customers
4.3 Thorne Company - Three GAAS in Fieldwork
4.4 Solar Technologies Inc. - Confirmation Request
4.5 Halston Toy Manufacturing Co. - Sales Returns
5.1 Audit of Trade Receivables
5.2 Estimation of Bad Debt Expense
5.3 Receivable Financing (Assignment And Factoring)
5.4 Discounting Of Note Receivable
5.5 Audit of Note Receivable
5.6 Audit of Loans Receivable
5.7 Reversal Impairment of Loans receivable
5.8 Audit of Sales
26 | P a g e
AUDIT OF RECEIVABLES AND SALES
Primary Risks for Accounts Receivable and Revenues
The main risks are:
 The company intentionally overstates accounts receivable and revenue
 Company employees steal collections
 Without proper cutoff, an overstatement of accounts receivables and revenue occurs
 Allowances are understated

1. Reconciliation of Subsidiary Ledger with General Ledger
An aged trial balance of trade accounts receivable at the audit date is commonly prepared for the auditors by
employees of the client, often in the form of computer printout. The client-prepared schedule is a multi-purpose form
designed for the aging of the customers’ accounts, the estimating of probable credit losses, and the controlling of
confirmation requests. The inclusion of so many phases of the examination of receivables in a single working paper is
practicable only for small concerns with a limited number of customers.
When trial balances are furnished to auditors by the client’s employees, some independent verification is essential.
Determination of the proper extent of testing should be made in relation to the adequacy of the internal controls over
receivables. The auditor should test the footings, cross-footings and agings.
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2. Confirmation of Receivables and Review of Subsequent Cash Receipt
The primary audit procedure to verify the existence and gross valuation of receivable is through confirmation. In
accordance with PSA 505 Revised and Redrafted, when using confirmation, the auditor can use either the positive and
negative confirmation, or a combination of the two methods to produce more effective procedures.
a. Positive Confirmation
It is sent to customer of the client by the auditor requesting a response directly as to whether the stated
amount owed is correct or incorrect, or to request the customer to provide specific information, such as their
account balance with the entity, which is referred to as “blank form”.
Positive confirmation is considered to provide more reliable audit evidence; however, it is more costly
compared to negative confirmation.
b. Negative Confirmation
It is sent to customer of the client by auditor requesting a response only if the customer disagrees with
the amount stated on the confirmation.
When to use Negative Method?
o The receivables comprise a large number of small balances.
o Internal control surrounding receivables is considered to be effective.
o The auditor reasonably believes that recipients of negative confirmation requests will give the
requests adequate consideration.
Negative confirmation provides audit evidence that is less reliable and less costly as compared to
positive confirmation. Non-response of the customer may either indicate that the customer agrees with
the information in the confirmation request or the customers just ignore the confirmation letter.
Other Audit Considerations When Using Confirmation:
 The confirmation request should be described that it is not a request for payment, but merely to confirm the
account.
 The confirmation request should be prepared and sent to the customer under the control of the auditor.
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 The auditor may include in the confirmation request the details of the transactions, such as customer’s purchase
order numbers to improve the response rate.
 The confirmation request should be mailed in envelopes bearing the CPA firm’s return address.
 Receipt of reply to confirmation request should be under the control of the auditor.
3. Evaluating the Adequacy of the Allowance for Doubtful Accounts

As part of risk in conducting a business, some customers may default from their payment. Since receivables need
to be valued at net realizable value, the company needs to make a reliable estimate of bad debts or doubtful accounts
in its financial statements. In some circumstances, receivables are proven to be worthless are written off.
An important part of obtaining evidence about the proper valuation of accounts receivable is the auditor's evaluation
of the adequacy of the allowance for uncollectible accounts. Since this account is a management estimate, it is typically
audited by one or a combination of the following procedures:
1. Evaluating management process of developing the estimate.
The auditor's evaluation ordinarily includes:
Obtaining a general understanding of the process used in developing the estimate;
a. Considering the reasonableness of the entity's policies regarding additions to the allowance and
write-offs of doubtful accounts
b. Discussing with management the key assumptions regarding collectability and evaluating the
reasonableness of the assumptions
c. Considering the effectiveness of the controls over the data used in the process
d. Evaluating the entity's method of calculating the allowance
2. Reviewing subsequent transactions.
Since the best evidence of collectability of receivable is payment by the debtors subsequent to the reporting
date, the auditor may review subsequent payment and ascertain the appropriateness of the provisions for bad
debts recorded.
3. Developing auditor's independent estimate.
Based on the knowledge gained by the auditor regarding the credit and collection process and management
process in developing the estimate, the auditor may come up with its independent estimate and compare it with
the management estimate.
Any significant difference should be investigated and resolved with the management (e.g., credit manager).
4. Expected Credit Losses

General Model: Three Stages
Stage 1: Insignificant Deterioration
 Estimate the probability of default in the first 12 months.
Illustration:
On Jan. 1, 2019, Zoom Bank provided a loan of 4M to D Company. Under the loan agreement, the
effective interest rate is 10% and that D Company is to pay the annual interest every Dec. 31. The principal
amount of the loan is due on Dec. 31, 2023.
Date Particulars Debit Credit

01/01/19 Loan Receivable 4,000,000
Cash 4,000,000
On Dec. 31, 2019, Zoom Bank needs to measure the 12-month expected credit loss for the loan.
Zoom Bank determined that the probability of default over the next 12 months is 1%.

12/31/19 Cash 400,000
Interest Income 400,000

12/31/19 Impairment Loss 18,140
Allowance for Credit Loss 18,140
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Computation of 12-month ECL
Carrying Amount, 12/31/19 P4,000,000.00
Less: PV of Expected Cash Flows (P4M x 0.683) (2,185,600.00)
Expected Credit Loss P1,814,400.00
Multiply by: Probability of Default 1%
12-month ECL P18,140.00
Stage 2: Significant Deterioration

 Review macro-economic factors, industry information, and reassessing risk in general.
 Estimate the probability of default for the remaining life of loan.
Continuation of the above illustration:
On Dec. 31, 2020, Zoom Bank has determined that there is a significant increase in credit risk of the
loan receivable. The probability of the loan being default over the life of the loan is 10%.

12/31/20 Cash 400,000

12/31/20 Impairment Loss 156,470
Computation of Impairment Loss

Less: PV of Expected Cash Flows (P4M x 0.7513) (2,253,900.00)
Multiply by: Probability of Default 10%
12-month ECL P174,610.00
Less: ECL Allowance, 12/31/19 (18,140.00)
Impairment Loss P156,470.00
Stage 3: Credit Impaired

 Estimate the probability of default over the loan’s remaining life and records a loss provision.
Continuation of the above illustration:
During 2021, D Company began to face financial difficulties. At year-end, Zoom Bank considered the
loan impaired. Interest for that year was collected. However, only 40% of the principal amount is expected to
be received on due date.
12/31/21 Cash 400,000
12/31/21 Impairment Loss 2,503,150
Loan Receivable 2,400,000
Computation of Impairment Loss

Less: PV of Expected Cash Flows (P4M x 40% x 0.8264) (1,322,240.00)
Less: ECL Allowance, 12/31/20 (174,610.00)
Impairment Loss P2,503,150.00
5. Accounts Receivable and Sales Cutoff

The auditor usually tests the sales cutoff by examining invoices and shipping documents for several days both
before and after the year-end and by tracing such documents to the sales and accounts receivable records for the
appropriate period.
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This test of sales cutoff may occasionally be made at an interim date to check the adequacy of the company’s
procedures. All substantial sales returns after the statement of financial position date should be reviewed carefully as
they may represent fictitious sales recorded at year-end.
6. Investigate any transactions with or related party receivables.

The auditor must determine the existence of related parties and identify significant related party transactions
including those not recognized in the accounting records. These related party relationships can provide opportunities
for individuals to act in a way that creates confusion to shareholders.
There are many related party transaction risks that materially affects the amount of receivables and sales that
appears in the financial statements of an entity. These include all of the contracts entered with related parties that have
substantially different terms than those similar transactions entered with unrelated parties. However, the auditors should
be concerned more with the possibility that an undisclosed relationship with a party to a material transaction has been
used to fabricate transactions.
After a related party receivable is identified and considered as material, the auditor should apply substantive
tests to that transaction by performing the following steps:
1. Recalculate the total balance of receivables in the subsidiary ledger and determine that it agrees with
the balance in the general ledger.
2. Review the list for potential problem accounts or large amounts and obtain an understanding of these
transactions and their potential collectability.
3. If the balances are significant, consider confirmation of several selected individual balances with the
related parties involved and reconcile replies. The auditor may also examine the invoices, executed copies of
contracts and other documents to support the balances.
4. Determine whether the transaction has been approved by the appropriate officials.
5. Determine the nature of any related party receivable that were written off during the audit period but
subsequently reinstated to the general ledger.
6. Determine the adequacy of disclosure in the notes of the transaction, balance of receivable and any
amount written off.
7. Analyzing credit balances and unusual items.

Customer's credit balances are credit balances in accounts receivable resulting from overpayments, returns and
allowances, advance payments from customers, or any unusual items caused by errors or irregularities in the accounts.
These credit balances are classified as current liabilities and not deducted from the debit balance of customer
accounts, except when the same is not material in which case only the net accounts receivable may be presented.
The auditors should identify and review the listings of credit balances for large or unusual items and test its
completeness. If the credit balance appearing on the customer's account is caused by a return of goods purchased,
the documents supporting such return of goods, such as credit memo and sales returns and allowances journal, must
be reviewed. It should be noted that the auditors must obtain an understanding of these credit transactions and their
impact on year-end receivables.
8. Ascertaining whether any receivables have been pledged or assigned.

Pledging of receivable happens when a client uses its receivables as collateral on a loan. Accounts receivable that
have been pledged are usually labeled by inserting an identifying code in the receivable records or stamping on a copy
of sales invoice that such receivable was pledged. But the auditors cannot proceed on the assumption that all pledged
receivables have been labeled in that effect and they must be alert to detect any suggestions of unrecorded pledging
of accounts receivable.
Receivables that were pledged or assigned must be disclosed in the notes to inform the reader of financial
statements that there is a contingent liability attached with such receivables. The auditors must review the footnotes
regarding the disclosures made for any factored, assigned or pledged receivables. Bank confirmation requests and
inquiry may also be used as a medium in gathering evidence of the pledging of receivables.
9. Performing analytical procedures.

During an audit, a variety of analytical procedures might be employed, depending on the circumstances and the
nature of the business. The auditors must first establish a threshold (it can be a percentage or an amount or both) in
performing analytical procedures, to determine the transactions that needs a thorough investigation.
Typical analytical procedures for sales include the following:
1. Compare sales for the last month of the fiscal to sales for the rest of the year and the first month after
year end.
2. Compare monthly sales returns and credit memos for the last few months of the fiscal year to the first few
months following year end.
Other analytical procedures can be performed by the auditors are trend analysis, comparison among sales units,
receivables turnover, days’ sales in receivables, amount of past due receivables, gross margin ratio, and sales/asset
ratios to historical data and industry statistics. Account interrelationships can also be used.
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For any significant difference or fluctuations noted, investigate the nature and cause of differences and consider
whether additional procedures are needed.
 Bill and Hold Transaction.

When a company engages in bill and hold transactions there is a possibility that the company is inappropriately
recognizing revenue. The auditors must ascertain that any transactions recognized as sales meet the criteria for
revenue recognition as set forth in SEC Accounting and Auditing Enforcement Release No. 108. In these
circumstances, the auditors will review the provisions of sales contracts and consider confirming the terms with
customers.
 Multiple Element Arrangement.
When a company sells using a multiple element arrangement, the revenue must be allocated to the elements
in relation to their fair values. Therefore, there is a possibility that management may attempted to misstate revenue
by inappropriate allocation. In these situations, the auditors will review the sales contracts and evaluate the
reasonableness of management’s allocation of the revenue to the various elements.
 Percentage of Completion Method.
When a company uses the percentage-of-completion method, there is a risk that management may
misestimate the amount of revenue earned on uncompleted contracts. The auditors must carefully evaluate the
costs allocated to the contracts and the estimates of the percentage-of-completion. In some cases, the auditors
may decide to engage a specialist, such as an engineer.
 Sales Returns.
When a company’s sales agreements allow for returns, there is a risk that management may misstate the
estimate of sales returns and, therefore, misstate revenue and receivables. In these situations, the auditors should
carefully review the contracts to determine that revenue should be recognized at the time of sale. If revenue
recognition is appropriate, they should next evaluate the adequacy of management’s estimate of sales returns.
 Receivables Denominated in Foreign Currency.
Portion of the receivables of an entity may be denominated in foreign currency as a result of sales, loan or
other transaction in that foreign currency. As required by the PAS 21 The Effects of Changes in Foreign Exchange
Rates, these receivables should be translated using the closing rate at the reporting date. The auditor ordinarily
obtains the closing rate and reperforms the translation of the foreign currency denominated receivables. The
auditor should also ensure that any foreign currency transaction gain or loss should be reported as part of profit or
loss.
 Analysis of Notes Receivable and Related Interest
An analysis of notes receivable supporting the general leger control account may be prepared for the auditor
by the client’s staff. The information in the analysis ordinarily includes the name of the maker, date, maturity,
amount and interest rate. In addition to identifying the accuracy of the analysis prepared by the client, the auditors
should trace items to the accounting records and to the note themselves.
After ensuring the accuracy of the items included in the analysis of notes receivable, the most effective
verification of the Interest Earned account consists of an independent computation by the auditors of the interest
earned during the year on notes receivable. The interest section of working paper consists of four columns showing
for each note receivable owned during the year the following information:
 Accrued interest receivable at the beginning of the year.
 Interest collected during the year.
 Accrued interest receivable at the end of the year.
 Interest earned during the year.
If the interest earned for the year as computed by the auditor does not agree with the interest earned as shown
in the accounting records, the auditor should investigate any difference as there may be unrecorded interest receipt
or notes that was not included in the analysis prepared by the client.
SITUATIONAL PROBLEM NO. 1 – Palisades Inc. .

Your regular annual audit of Palisades, Inc., included in the confirmation of accounts receivable. You decided
to use the positive form of confirmation request. Satisfactory replies were received from all but one of the large
amounts. You sent a second and third request to this customer, but received no reply. At this point an employee
of the client company informed you that a check had been received for the full amount of the receivable. Would
you regard this as a satisfactory disposition of matter?
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Discussions on the case:
No. The matter remains unresolved. First, oral evidence from the client is seldom in itself sufficient; the auditors
must follow up to determine the reliability of the oral evidence. Second, payment of an account receivable is not
confirmation; the account might be fictitious, and the "payment" could have been made by a dishonest employee
who had created the fictitious account to conceal a cash shortage. The auditors must examine the customer
purchase order or contract, and copies of the sales invoice and shipping document in support of the unconfirmed
receivable. They should may also determine the genuineness of the customer by reference to the telephone
directory or to credit agency reports.
SITUATIONAL PROBLEM NO. 2 – Lakeside Company .

Lakeside Company has retained you to conduct an audit so that it will be able to support its application for a
bank loan with audited financial statements. The president of Lakeside states that you will have unlimited access
to all records of the company and may carry out any audit procedures you consider necessary, except that you are
not to communicate with customers. The president feels that contacts with customers might lead them to believe
that Lakeside was in financial difficulty. Under these circumstances, will it be possible for you to issue the auditors’
standard unqualified audit report?
Confirmation of accounts receivable by direct communication with debtors is usually essential to the issuance
of an unqualified audit report. Confirmation of receivables is a presumed procedure, and failure to perform such a
procedure when issuing an unqualified report requires justification in the working papers. The auditors must
generally disclaim an opinion on the client’s financial statements when they have been forbidden by the client to
confirm receivables.
SITUATIONAL PROBLEM NO. 3 – Thorne Company .

Elizabeth Cole, the senior-auditor-in-charge of auditing statements of Thorne Company, a small manufacturer,
was busy writing the audit report for another engagement. Accordingly, she sent Martin Joseph, a recently hired
staff assistant of the CPA firm, to begin the audit of Thorne Company, with the suggestion that Joseph start with
the accounts receivable. Using the preceding year’s audit working papers for Thorne Company as a guide, Joseph
prepared a trial balance of Thorne’s accounts receivable, aged them, prepared and mailed positive confirmation
requests, examine underlying documents plus other support for charges and credits to the Accounts Receivable
ledger account, and performed such other work as he deemed necessary to assure the validity and collectability
of the accounts receivable.
At the conclusion of Joseph’s work, Cole travelled to Thorne Company to review Joseph’s working papers,
Cole found that Joseph had carefully followed the prior year’s audit working papers. Does the three generally
accepted auditing standards of field fulfilled or not fulfilled in the audit of Thorne Company?
All three generally accepted auditing standards of field work were violated in the audit of the accounts
receivable of Thorne Company. The first standard of field work, which requires adequate planning of the audit and
proper supervision of assistants, was obviously violated. Planning was inadequate because no audit plan, audit
programs, or time budgets were prepared. Supervision was inadequate because Martin Joseph, an inexperienced
staff assistant, was left on his own to audit the accounts receivable, with no guidance from the senior auditor.
The second standard of field work, which requires the auditors to obtain an understanding of the entity and its
environment, including existing internal control, was violated. Martin Joseph did not obtain an understanding of the
internal control for the business processes related to accounts receivable, nor did he perform tests of controls over
receivables and sales transactions. Obviously, the substantive procedures that Joseph applied to Thorne
Company’s accounts receivable were merely a repetition of the preceding year’s audit procedures.
The third standard of field work, which requires the obtaining of sufficient competent evidence matter, was
violated because no assessments of the risks of material misstatement were performed. What constitutes
sufficient, competent evidence in an audit is determined principally by the assessed levels of risks of material
misstatement (inherent and control risks).
SITUATIONAL PROBLEM NO. 4 – Solar Technologies, Inc. .

During the audit of Solar Technologies, Inc. The auditors sent confirmation request to customers whose
accounts have been written off as uncollectible during the year under audit. An executive of Solar protested saying:
“You people should be verifying that the receivables on the books are collectible. We know the ones we wrote are
no good.”
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Required:
a. What purpose, if any, is served by this audit procedure?
b. Does the Solar executive’s statement suggest some misunderstanding of audit of objectives? Explain.
a. When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the
auditors’ purposes are to determine that the receivables were genuine when they were first recorded in the
accounts and to determine that the accounts were not collected and the proceeds stolen. In some fraud cases,
fictitious accounts receivables have been created to cover up a shortage. Eventually these fictitious receivables
must be disposed of; one method is to write off the fictitious accounts as uncollectible. In other cases, valid
accounts receivables have been collected, but written off as uncollectible by the employee who has procured
the funds.
b. The Solar executive appears to believe the auditors are solely concerned with the valuation or collectability of
accounts and notes receivable. In fact, the confirmation process is primarily intended to establish that the
receivables are valid and that the customers (or makers of notes) exist. Other audit procedures are followed
to determine proper valuation.
SITUATIONAL PROBLEM NO. 5 – Halston Toy Manufacturing Co. .

Halston Toy Manufacturing Co. introduced a number of new products in the last quarter of the year. The
company has a liberal return policy allowing retail customers to return products within 120 days of purchase.
Required:
a. Describe the audit problem indicated by this scenario.
b. List audit procedures that could be used to audit the allowance for sales returns.
a. Due to the fact that Halston has a number of new products and a liberal return policy, it may be very difficult to
estimate the allowance for sales returns. With new products it may be difficult to use prior return history to
estimate the amount of returns.
b. The auditors might consider performing the following procedures:
1. Review any trade journals and industry data that might have information relevant to sales of the new
products.
2. Review trends in sales returns in prior periods, especially when new products were introduced.
3. Make inquiries of sales personnel about customer feedback on sales of the new toys.
4. Review sales returns given in the subsequent period and compare the amounts to prior periods
PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – Primo Inc. (Audit of Trade Receivables) .

You were assigned to audit the existence assertion of Primo Inc.'s receivables as of December 31, 2018. You have
decided to send confirmation letters to pre-selected customers. The following is a summary of the confirmation replies
of client customers where you noted audit exceptions. Gross profit on sales is at 30% and inventory records are kept
under the perpetual inventory method.
Customer Balance per Customer's Comments Audit findings
Books
Your Credit Memo No. 0978 representing
The Credit Memo was taken up by
UNO Inc. P30,000 price adjustment dated December 29, 2018
PRIMO Inc. in January 2019.
cancels this.
Returned goods were received on.
P140,000 was for Sales Invoice No. 1190
DOS December 31, 2018. Credit Memo No.
P300,000 were for goods returned on December 30,
Corp. 1256 were issued and recorded on
2018. Correct balance is P160,000.
January 5, 2019
This is for outstanding sales invoice No.
1280 which should have been priced at P122
Tres Co. P288,000 The customer complaint is valid.
per unit. You erroneously billed us P144 per
unit.
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Our records show a correct balance of
PRIMO Inc. recorded the transaction as
P220,000 The difference is for Sales Invoice
a purchase by crediting accounts
Kwatro No. 1109 which were for goods delivered to
P265,000 payable for 45,000. The related
Inc. us but were subsequently returned to you
inventories were appropriately. Taken
because the goods were with wrong
in-the perpetual records.
specifications.
This is for Sales Invoice No. 1341. We The goods were delivered on
Cinco
P122,000 received the corresponding goods only on December 30, 2018 under term FOB
Corp.
January 5. Shipping Point
Questions:
1. What is the effect to the net income, if there are any, as a result of the customer's UNO Inc. reply?
2. What is the effect to the net income, if there are any as a result of the customer's DOS Corp.'s reply?
3. The accounts receivable from Tres Co. is Overstated(Understated) by how much?
4. What is the effect to the net income, if there are any, as a result of the customer's Kwatro Inc. reply?
5. The accounts receivable from Cinco Corp. is?
1.) Decrease by P30,000
Adjusting entry:
Sales 30,000
Accounts Receivable 30,000
2.) Decrease by P42,000.
Adjusting entry:
Sales Returns 140,000
Inventories 98,000
Cost of Sales 98,000
3.) Overstated by P44,000

Adjusting entry:
Sales 44,000
4.) No effect.
Adjusting entry:
Sales 45,000
Accounts Payable 45,000

Purchases 45,000
*Note that the inventories were appropriately taken in the perpetual records.
The Debit to Sales return is offset by the Credit to Purchases, thus no effect to net income
*Note that the inventories were appropriately taken in the perpetual records.
The Debit to Sales return is offset by the Credit to Purchases, thus no effect to net income
5.) P122,000.00
The transaction is a valid sale as it is in transit FOB Shipping point.
PROBLEM NO. 2 – San Antonio Corporation (Estimation of Allowance for Doubtful Accounts) .
As part of your engagement to audit the financial statements of San Antonio Corporation, you have been assigned to
examine the accounts receivable. You gathered the following data from the trial balance as of December 31, 2018:
Accounts Receivable P2,000,000.00
Allowance for Doubtful Accounts 100,000.00
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You determined the following from the schedule of accounts receivable as of December 31, 2018:
Accounts with debit balances
60 days old and below P1,000,000.00
61 to 90 days 500,000.00
Over 90 days 400,000.00 P1,900,000.00
Advances to officers 150,000.00
Less: Accounts with credit balances (50,000.00)
Accounts receivable per GL P2,000,000.00
Additional information:
o Accounts receivable for more than a year totaling to P20,000 should be written off.
o On November 1, 2018, goods amounting to P50,000 were shipped to ABC Co, FOB shipping point but the
same has not been recorded by the company. No collection has yet been made by the company on this
account.
o The bank returned on December 29, 2018, a customer's check for P30,000 marked "No Sufficient Funds", but
no entry was made. The customer's invoice was dated and recorded on December 1, 2018.
o Confirmation replies received directly from customers disclosed the following exceptions:
CUSTOMERS BALANCE COMMENTS FROM CUSTOMERS AUDIT FINDINGS

San Antonio received mailed check on
Balance was paid December 29,
Tim P 10,000 January 3, 2019, Tim was billed on
2018.
December 5, 2018
San Antonio credited accounts payable
Balance was offset by our
Tony 14,800 for P14,800 to record purchase of tires.
December 10 shipment of tires.
Tony was billed on October 28, 2018.
The payment was credited to customer
Boris 32,000 The above balance has been paid. Parker. Boris was billed on September
4, 2018.
Our records show a bigger balance, A new confirmation was mailed Parker
Parker 20,000
please check. was billed on November 25, 2018.
We do not owe San Antonio on The shipment costing P20,500 was
December 31 as goods were made on December 29, 2018 but the
Leonard 47,400
received in January 3, 2019, FOB goods were included in recording the
destination December 31, 2018 inventory
San Antonio had previously credited the
Our deposit of P90,000 should cover deposit to sales. The P30,000 worth of
Danny 30,000
this balance. merchandise was shipped and billed on
December 1, 2018.
Sure we ordered P20,000 of
merchandise on October 10, 2018 The goods were shipped FOB Shipping
Kawhi but San Antonio was out of-stock point on December 15, 2018 and billed
20,000
until recently. They back ordered the on the same date.
goods and we finally received them
on January 6, 2019.
Based on your discussion with San Antonio's Credit Manager, you both agreed that an allowance for doubtful accounts
should be maintained using the following rates:
60 days old and below 4%

61 to 90 days 5%
Over 90 days 10%
Questions:
1. What is the adjusted allowance for doubtful accounts as of December 31, 2018?
2. What is the adjusted balance of the doubtful accounts expense for the year ended December 31, 2018?
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TOTAL 60 days and 61-90 days Over
below 90 days
A/R, unadjusted balance P1,900,000.00 P1,000,000.00 P500,000.00 P400,000.00
Write off (20,000.00) - - (20,000.00)
Unrecorded sales 50,000.00 50,000.00 - -
NSF check 30,000.00 30,000.00 - -
Sales-Tony (14,800.00) - (14,800.00) -
Payment of Boris - - - -
Credited to Parker - 32,000.00 - (32,000.00)
Overstatement of sales -
Leonard (47,400.00) (47,400.00) - -
Sales - Danny (30,000.00) (30,000) - -
Adjusted balance 1,867,800.00 1,034,600.00 485,200.00 348,000.00
Multiply by: age uncollectible - 4% 5% 10%
1.) Allowance for DA P100,444.00 41,384 24,260 34,800
Allowance for Doubtful Accounts

Write off 20,000 100,000 Beg. Balance
Balance end (required) 101,444 Recoveries
21,444 Doubtful account expense (squeeze) 2.)
Total 121,444 121,444
PRACTICAL PROBLEM NO. 3 – Odette Corp. (Financing Transactions) .

Odette Corp. had the following receivable financing transactions during the year:
 On March 1, 2019, Odette Corp. factored P500,000 of its accounts receivables to BPI. As of the date of
factoring, it was ascertained that P20,000 of the accounts receivable is doubtful of collection. BPI advanced
P350, 000 cash to Odette Corp. and withheld P50,000 as factors holdback (to cover future sales discount and
sales returns and allowances). The company incurred P10,000 direct transaction costs (legal fees and other
professional fees) related to the factoring. The factoring was done on a without-recourse basis, thus
transferring all significant risks and reward associated to the receivable to BPI.
 On May 1, 2019, Odette Corp. assigned P800,000 of its outstanding accounts receivable to BDO in
consideration of a P500.000, 24% loan. BDO charged the company 2% of the accounts assigned as service
charge. By the end of May, Odette Corp. collected P200,000 cash from the assigned accounts net of a P5,000
sales discount. By the end of June, Odette Corp, collected another P150,000 from the assigned accounts after
P4,000 sales discount. The company accepted merchandise originally Invoiced at P30,000 as sales returns
and wrote-off P20,000 of the assigned accounts as worthless. It was agreed between parties that monthly
collections shall be remitted to the bank as partial payment of the loan and interest.
Questions:
1. How much should be reported as gain/loss in the income statement on the transfer of receivables on the factoring
of receivable on March 1?
2. How much should be reported as gain/loss in the income statement on the transfer of receivables on the assignment
of receivable on May 1?
3. What is the carrying value of the accounts receivable-assigned as of June 30?
4. What is the carrying value of the loans payable related to the accounts receivable assigned as of June30?
Net Selling Price:

Cash Received P350,000.00
Add: Receivable from factor 50,000.00
Less: Factoring Fee (10,000.00) P390,000.00
Less: Carrying Amount of A/R
(480,000.00)
(500,000-20,000)
1.) Loss on Factoring (P90,000.00)
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2.) P0.00
There is no gain/loss in assignment of receivables because it is a secured borrowing and not a sale.
A/R – Assigned, Beginning balance P800,000.00

Less: Cash Collections – May (200,000.00)
Sales Discount – May collections (5,000.00)
Cash Collections – June (150,000.00)
Sales Discount – June collections (4,000.00)
Sales Return (30,000.00)
Write-off (20,000.00)
3.) A/R – Assigned, ending balance P391,000.00
Loan Payable to BDO P500,000.00

Less: Collection – May 31 200,000.00
Less: Interest (10,000.00) (190,000.00)
Collection – June 30 150,000.00
Less: Interest (6,200.00) (143,800.00)
4.) Carrying Amount of the Loan P166,200.00
PRACTICAL PROBLEM NO.4 – Precious Co. (Discounting of Notes Receivable) .

The following were noted during your audit of the Precious Co. for the calendar year 2019:
Notes Receivable
Sept. 1 Dianne, 21%, due in 3 months P 320,000.00
Oct. 1 Jane Co., 24%, due in 2 months 1,200,000.00
1 Discounted Dianne note at 24% P320,000.00
Nov. 1 Keith, 24%, due in 13 months 2,400,000.00
30 Vren Co., no interest, due in one year 2,000,000.00
30 Discounted Vren Co. note at 12% 2,000,000.00
Dec. 1 Alfonso Co, 18%, due in 5 months 3,600,000.00
1 Ms. Anna, President, 12%, due in 3 months 4,800,000.00
(For cash loan given to Ms. Anna)
All notes are trade notes receivable unless otherwise specified. The Dianne note was paid on December 1 as per
notification received from the bank. The Jane Co. note was dishonored on the due date but the legal department has
assured management of its full collectability.
The Company, with your concurrence, will treat the discounting as conditional sale of Notes Receivable.
Questions:
Based on the above and the result of your audit, answer the following:
1. At what amount on the current assets section of the balance sheet as of December 31, 2019 will Notes Receivable
- Trade be carried?
2. What Amount of Loss on Note Receivable discounting should be reported in 2019 Income Statement of the
Company?
3. How much is the accrued interest income as of December 31, 2019?
Receivable from Keith P2,400,000.00
Receivable from Alfonso 3,600,000.00
1.) Total Current trade notes receivable P6,000,000.00
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Net Proceeds:
Principal P320,000.00
Add: Interest (320,000*21%*(3/12)) 16,800.00
Maturity Value P336,800.00
Less: Discount (336,800*24%*(2/12)) (13,472).00 P323,328.00
Less: Book Value
Principal P320,000.00
Add: AIR (320,000*21%*(1/12)) 5,600.00 (325,600.00)
Loss on Discounting of Dianne Note (P2,272.00)
Loss on Discounting of Vren Note:
Principal/Maturity Value P2,000,000.00
Less: Discount (240,000.00)
Net Proceeds P1,760,000.00
Less: Book Value (2,000,000.00) (P240,000.00)
2.) Total P242,272.00
Jane (P1,200,000 x 24% x 3/12) P72,000.00

Keith (P2,400,000x 24% x 2/12) 96,000.00
Alfonso (P3,600,000 x 18% x 1/12) 54,000.00
Ms. Anna (P4,800,000x 12% x 1/12) 48,000.00
3.) Total accrued interest receivable P270,000.00
PRACTICAL PROBLEM NO. 5 – Flordeliz Co. (Audit of Note Receivables) .

You are engaged in the audit of Flordeliz Co., a new client, at December 31 2018. You review the following notes
receivable and other related interest income accounts in the general ledger:
Notes Receivable
Beg. Bal P1,700,000 P1,350,000 Balance end
Apr. 1, 2018 250,000 500,000 04/01/2018
100,000 2/31/2018
P1,950,000 P1,950,000
Interest Income
Bal. end P 180,000 P 180,000 04/01/2018
180,000 P 180,000
A. The beginning balance of the notes receivable is composed of the following,
o Note received from sale of machinery on January 1, 2017 costing P800,000 with accumulated depreciation of
P450,000. The company receives as consideration of P200,000 and a noninterest bearing note for P300,000
due annually in equal amounts of P100,000 every December 31, starting December 31, 2017. The prevailing
rate of interest for note of this type is 12%. The company made the following entry on January 1, 2017:
Cash 200,000
Notes Receivable 300,000
Accumulated Depreciation 450,000
Equipment 950,000
The company credited the notes receivable account when it received the P100,000 annual payment on
December 31, 2017. The same entry was made on December 31, 2018 regarding the collection.
o Note receivable from sale of plant dated April 1, 2017 amounts to P1,500,000 which bears interest at 12% per
annum. No gain or loss was realized from sale. The note is payable in 3 annual installments P500,000 plus
interest on the unpaid balance every April 1. The initial principal and interest payment was made on April 1,
2018.
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The company made the following entry:
Cash 680,000
You found out that no accrual of interest was made in 2017 and 2018
b. The entry on April 1, 2018 represents the note received when it sells equipment from the XYZ Corp on April 1, 2018.
The equipment cost P1,000,000 and has accumulated depreciation of P400,000 on the date of sale. The company
receives as consideration P350,000 and a noninterest bearing note for P250,000 due on April 1, 2022. The prevailing
rate of interest for a note of this type is 10%. The following entry was made by the company on April 1, 2018:
Cash 350,000
Equipment 1,000,000
No additional entry was made on December 31. 2018.
Questions:
Based on the above data, compute for the following:
1.The adjustment to retained earnings as of January 1, 2018.
2 The total interest income in 2018.
3. Current portion of long-term receivables as of December 31, 2018.
4. Noncurrent receivables as of December 31, 2018.
5. Assuming that none of the errors were detected and corrected in 2018, the net income in 2018 would be?
Unrecorded gain on sale of machinery - 2017 (see below) *P90,183.00

Unrecorded interest income - receivable from sale of machinery (240,183 x 12%) **28,822.00
Unrecorded accrued interest receivable from sale of plant (1,500,000x 12% x 9/12) 135,000.00
1.) Net adjustment to R/E - 01/01/18 P254,005.00
Cash consideration P200,000.00

Add: Present value of future cash flows (2.4018 x 100,000) 240,183.00
Total selling price P440,183.00
Less: Carrying value of machine (800,000 - 450,000)
(350,000.00)
Gain on sale of machine *P90,183.00
Amortization table (receivable from sale of machinery)
Date Collections Interest Amortization Carrying
Income Amount
01/01/2018 240,183
12/31/2018 100,000 **28,822 71,178 169,005
12/31/2019 100,000 20,281 79,719 89,286
12/31/2020 100,000 10,714 89,286 –
Interest income from note receivable:

Sale of machinery (169,005 x 126) P20,281.00
Sale of plant [(1,500,000 x 12% 3/12) + (1M x 12% x 9/12) 135,000.00
Sale of equipment (170,750 x 10% x 9/12) 12,806.00
2.) Total interest income P168,087.00
Current portion of note receivable from:

Sale of machinery (see amortization table above) P89,286.00
Sale of plant 500,000.00
3.) Total current portion P589,286.00
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Non-current portion of note receivable from:
Sale of equipment (P170,750 + P12,806) P183,556.00
Sale of plant 500,000.00
4.) Total non-current portion P683,556.00
Interest income from sale of machine P20,281.00

Interest income from sale of plant (180,000 -135,000) (45,000.00)
Interest income from sale of equipment 12,806.00
5.) Net overstatement of income (P11,912)
PRACTICAL PROBLEM NO. 6 – Esme Financing Corp. (Audit of Loans Receivables) .

In the course of your audit of the Loans receivable account of Esme Financing Corp, a lending company, for the year
ended December 31, 2018, you discovered the balance per its general ledger of its Loans receivable from Franco was
at P4,000,000.
Audit notes:
a. The loan to FRANCO is a non interest bearing loan which shall mature on December 31, 2020.
b. The loan was originated on January 1, 2016.
c. The total amount disbursed on that date was based on the appropriate discount rate prevailing on that date
at 10%.
d. The transaction was recorded by the client as a debit to loans receivable at face value of the loan charging
interest income for its difference to the amount credited to cash.
Question:
1. What is the retroactive, adjustment to retained earnings beginning, if any, as a result of your audit of loans receivable
from FRANCO?
Suggested Solution:
Loan Proceeds (P4,000,000*.6209213) P2,483,685.00
Correct journal entry:
Loan Receivable 2,483,685
Cash 2,483,685
Amortization Table
Date Interest Interest Amortization Carrying
Income Received Amount
01/01/2016 2,483,685
12/31/2016 248,369 - 248,369 2,732,054
12/31/2017 273,205 - 273,205 3,005,259
12/31/2028 300,526 - 300,526 3,305,785
Adjusting Journal entry at the Beginning of 2018:

1.) Retained Earnings, beg 994,741
Loan Receivable 994,741
Principal Amount P4,000,000.00
Less: Proceeds (2,483,685.00)
Interest Income Recognized in 2016 P1,516,315.00
Correct Interest Income in 2016 (248,369.00)
Correct Interest Income in 2017 (273,205.00)
Overstatement in interest income P994,741.00
PRACTICAL PROBLEM NO. 7 – KADITA Co. (Reversal of Impairment Loss) .

On January 1, 2015, KADITA Co. granted a 5 year of P1,000,000 to VALE Inc. Principal payments of P200,000 and
interest at 10% are due annually at the end of each year for 5 years. The first payment starts ön December 31, 2015.
VALE, Inc. made the required payments during 2015 and 2016. However, during 2017, VALE Inc. began to experience
financial difficulties, requiring KADITA Co. to reassess the collectability of the note. Interest was accrued 2017. On
December 31, 2017, KADITA Co. determined that the note has been impaired and projects that only the remaining
principal is collectible.
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The expected future cash flows are as follows:
Expected Date of Collection Amount of Cash Flow
December 31, 2018 P140,000.00
December 31, 2019 200,000.00
December 31, 2020 260,000.00
 The amount of the impairment loss in 2017 based on these cash flows was P212,108.
 On December 31, 2018, VALE's credit rating has improved and the loan was then again restructured. After
receiving the scheduled collection on December 31, 2018 the present value of the remaining cash flows on
the newly restructured loan is P654,552.
Immediately before the restructuring on December 31, 2018, the loan has a carrying amount of P396,681. If no
impairment loss had been recognized previously, the loan would have a carrying amount of P600,000 as of December
31, 2018.
Questions:
Based on the above data, answer the following:
1. How much is the gain on reversal of impairment to be recognized in 2018 in accordance with PAS 39?
2. How much is the gain on reversal of impairment to be recognized in 2018 in accordance with PFRS 9?
3. How much is the interest income for 2019 in accordance with PAS 39?
4. How much is the interest income for 2019 in accordance with PFRS 9?
Suggested Solution:
Present value of expected cash flows P654,552.00
Versus: Would have been present value if there was no
impairment 600,000.00
Lower P600,000.00
Less: Actual Amortized Cost (396,681.00)
1.) Gain on reversal of impairment loss (PAS 39) P203,319.00
Present value of expected cash flows P654,552.00
Less: Actual Amortized Cost (396,681.00)
2.) Gain on reversal of impairment loss (PFRS 9) P257,871.00
3.) Interest income (600,000 x 10%) (PAS 39) P60,000.00
4.) Interest income (654,552 x 10%) (PFRS 9) P65,455.00
PRACTICAL PROBLEM NO. 8 – Viva Merchandising (Audit of Sales) .

As part of your audit of receivables of Viva Merchandising, which has an unadjusted balance per ledger at P276,500,
you performed a cut-off test of sales.
Furthermore, you observed the physical count of the client’s goods on December 30, 2019 and that you ascertained
that all goods delivered on or before the count date were excluded from the said count. The client records revealed
that inventory balance resulting from the physical count was at P120,000.
Results of the cut-off test revealed the following:
Recorded as Sales in December 2019
SI No. Selling price Cost Terms Shipment Date Received by customers
1121 P18,000.00 P16,500.00 FOB shipping point 12/26/2019 12/29/2019
1122 12,500.00 10,200.00 FOB destination 12/26/2019 12/29/2019
1123 8,680.00 7,240.00 FOB destination 12/28/2019 01/02/2020
1124 14,200.00 12,500.00 Shipped to consignee 12/29/2019 01/02/2020
1125 9,000.00 7,500.00 FOB shipping point 12/30/2019 01/02/2020
1126 10,000.00 7,750.00 FOB destination 12/31/2019 01/03/2020
1127 7,800.00 6,100.00 FOB destination 12/31/2019 01/02/2020
1128 14,000.00 12,000.00 Shipped to consignee 12/31/2019 01/02/2020
Recorded Sales in January 2020
SI No. Selling price Cost Terms Shipment Date Received by customers
1129 P21,000.00 18,200.00 FOB shipping point 12/31/2019 01/03/2020
1130 10,500.00 8,800.00 FOB destination 12/31/2019 01/03/2020
1131 4,500.00 3,200.00 FOB destination 01/02/2020 01/03/2020
1132 6,500.00 5,000.00 FOB shipping point 01/02/2020 01/05/2020
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Question:
1. What is the correct balance of the accounts receivable as a result of your sales cut-off?
Suggested Solution:
Accounts Receivable Sales
Unadjusted P276,500.00
SI No. 1121 - P18,000.00 Recorded and sold
SI No. 1122 - 12,500.00 Recorded and sold
SI No. 1123 (8,680.00) - Recorded but unsold
SI No. 1125 9,000.00 Recorded and sold
SI No. 1127 7,800.00 Recorded and sold
SI No. 1129 21,000.00 21,000.00 Unrecorded but sold
SI No. 1130 - - Unrecorded and unsold
1.) TOTAL P250,620.00 P68,300.00
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OUTLINE
1. Introduction
1.1 Auditors' Objective in the Audit of Inventories & Cost of Sales

2.1 Evaluate Client's Planning of Physical Inventory
2.2 Observe Inventory Count & Make Test Counts
2.3 Reconcile Inventory Summary Sheet with General Ledger
2.4 Year-End Inventory/ Purchase Cutoff
2.5 Valuation in accordance with accounting policies
2.6 Lower-of-Cost-or-Net Realizable Value Test
2.7 Audit on Consigned Inventory

3.1 Analytical Procedures for Inventory
3.2 Determining Existence of Collateral Agreements
3.3 Reviewing Purchase Commitment Agreements
3.4 Examining Treatment of Overheads in Cost of Inventories
3.5 Evaluate financial statement presentation of inventories and cost of goods sold, including the adequacy of
disclosure
4. Situational problems
4.1 Janna Corp. - Management Fraud
4.2 ABC and EVIL Company – Collusion and Kickback
4.3 MANG Company – Detecting Theft
4.4 Western Trading Company – Subsequent Discovery of the Auditor Immediately Before the Report Release
Date
4.5 C.T. Drugstore – Improper Planning of Inventory Count
5. Practical Problems
5.1 Mar Co. - Adjustment of Accounts at Year-End
5.2 JayDee Company - Estimated Value on Missing Accounts
5.3 Ivy Inc. - Net Adjustment to Various Accounts and Net Effect on Net Income
5.4 Akihito Co. - Reconciliation of Physical Inventory with Shipment Terms
5.5 Tetsuya Kuro Co. - Misstatement of Inventory
5.6 ABS-CBN Corporation - Adjustment of Accounts at Interim Period
5.7 The Great Gatsby Mfg. - Audit Response for Test Counts
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AUDIT OF INVENTORIES AND COST OF SALES
Auditors' Objective in the Audit of Inventories & Cost of Sales

 Use the understanding of the client and its environment to consider inherent risks, including fraud risks.
Generally, inventories represent an asset with significant inherent risks. Some of these risks arise from business
risks faced by management, such as risk of losses due to poor product quality, obsolescence, or theft.
Other factors that affect the risk of material misstatement of inventories
o Inventories often represent a very substantial portion of current assets.
o Numerous valuation methods are used for inventories.
o The valuation of inventories directly affects costs of goods sold.
o The determination of inventory quality, condition, and value is inherently complex.
 Obtain an understanding of internal control over inventories and cost of goods sold.
The auditors should be thoroughly familiar with the procedures for purchasing, receiving, storing and issuing goods
and for controlling production. In an organizational structure with strong internal control over purchases, the purchasing,
receiving, and recording functions are clearly separated and lodged in separate departments.
The auditors should also give consideration to the physical protection of inventories. Deficiencies in storage
facilities, in guard service, or in physical handling that may lead to losses from weather, fire, flood, or theft may
appropriately be called to the attention of management.
The matters to be investigated by the auditors in consideration of controls over inventory and costs of goods sold
are fairly well indicated by these questions:
o Are perpetual inventory records maintained for each class of inventory?
o Are perpetual inventory records verified by physical inventories at least once a year?
o Do the procedures for physical inventories include the use of prenumbered tags, with all tag numbers
accounted for?
o Are perpetual inventory records verified by physical inventories at least once a year?
o Are differences between physical inventory counts and perpetual inventory records investigated before
the perpetual records are adjusted?
o Is a separate purchasing department responsible for purchasing all materials, supplies, and equipment?
o Does a separate receiving department process all incoming shipments?
o Are materials and supplies held in the custody of the stores department and issued only upon receipt of
properly approved requisitions?
 Assess risk of material misstatement and design further audit procedures.
The auditors must consider the relationships between specific misstatements & controls. The auditors'
assessments of the risk of material misstatement are used to design further audit procedures.
 Perform Test of Controls
Test directed towards the effectiveness of controls help to evaluate the client's internal control and determine
whether the auditors can support their planned assessed levels of control risk for the assertions about inventory.
 Perform Substantive Procedures for Inventories

1. Evaluate Client's Planning of Physical Inventory
Cooperation between the auditors and the client personnel in formulating the procedures to be followed will prevent
unnecessary confusion and will aid in securing a complete and well-controlled count.
The matters to be investigated in the auditors’ consideration of controls over inventory and costs of goods sold are
fairly well indicated by these questions:
o Selecting the best date/dates
o Suspending production in certain departments
o Segregating obsolete & defective goods
o Establishing control over the counting process through the use of inventory tags or sheets
o Proper cut-off over the sales & purchase transactions
o Arranging the services of specialist
Once the plan has been developed, it must be documented and communicated in the form of written instructions
to the personnel taking the physical inventory.
These instructions normally will be drafted by the client and reviewed by the auditors, who will judge their adequacy.
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2. Observe Inventory Count & Make Test Counts
It is not the auditors’ function to take the inventory or to control or supervise the taking; this is the responsibility of
the management. The auditors’ responsibility is to observe the inventory taking.
The actual counting, the filling in of inventory tags, and the pulling of these tags are done by the client’s employees.
The client often transfers the information listed on the inventory tags to serially numbered inventory sheets.
While the inventory tags are still attached to the goods, the auditors may make test counts as they deem
appropriate. If these test counts indicate a discrepancy between the number of items counted and the inventory count
sheet, the goods are recounted once by the client and the errors are corrected.
Inventory verification when the auditors are engaged after the end of the year
a. Examining internal control on inventories.
b. Examining the availability of instructions and other records showing the client had carried out well-planned
inventory count.
c. Performing test counts on some items considered material and significant.
3. Reconcile Inventory Summary Sheet with General Ledger
The review of the reconciliation of the inventory summary sheet with the general ledger will consists of:
 Footing the reconciliation.
 Reconciling the book & physical inventory figures to the compilation and uncorrected general ledger.
 Investigating significant differences between book and physical inventories.
 Reviewing the nature of reconciling items.
 Agreeing reconciling items to the supporting WP, adjusting journal entries and the general ledger.
4. Year-End Inventory/ Purchase Cutoff
Common purchase cut-off concern:
 Shipments received but purchase invoice received in the next period.
A shipment of goods costing 10,000 is received from a supplier on December 31, but the purchase invoice
does not arrive until January 2, and is recorded in January transaction.
 Purchase invoice received but merchandise received in subsequent period
A purchase invoice is received and recorded on December 31, but the merchandise covered by the invoice
is not received until January 2 and is not included in the physical inventory at year end.
The cut-off procedures may consist of:
a. Examining a sample of receiving reports for inventory receipts immediately before & after the inventory
count to check whether it is recorded in the correct accounting period.
b. Examining a sample of shipping documents for shipments immediately prior to and subsequent to the count
to check whether “i” is recorded in the correct accounting period.
5. Valuation in accordance with accounting policies
The investigation of inventory valuation often will emphasize the following three questions:
 What method of valuation does the client use?
Method of valuation – PAS 02 Inventories generally prescribes lower of cost or net realizable value
 Is the method of pricing the same as that used in prior years?
Change in method of valuing inventory – The auditor should ensure that the change is appropriately
accounted in accordance with PAS 08 – Accounting Policies, Changes in Accounting Estimates and
Errors.
 Has the method selected by the client been applied consistently and accurately in practice?
Consistent application in practice of the method of valuation – Auditors must test the pricing of a
representative number of inventory item.
6. Lower-of-Cost-or-Net Realizable Value Test
LCNRV generally involves comparing the recorded amount of sample inventory with its net realizable value. To
determine whether the inventory valuation method used by the client has been properly applied, the auditors must
make tests of the pricing of selected items of finished goods and goods in process.
To verify the NRV of inventories, the following should be observed:
a. Finished Goods – selling price less any estimated cost to dispose them
b. Work-in-Process – selling price less any estimated cost to complete and dispose the item
c. Raw Materials – replacement cost less any estimated cost to complete and dispose the item
Any write down to net realizable value and reversal of write down should be charged to expense (i.e. Cost of Goods
Sold) in accordance with PAS 02 Inventories.
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7. Audit of Goods Out on Consignment
In the consignment of goods, the issue on audit is:
 Who owns the goods? Whether the company owns and have control over the goods within their
warehouses.
 Are there any consigned (out) goods currently existing? Are they properly included in the ending
inventory?
 Are consigned (in) goods excluded from the physical count?
 Are these goods properly disclosed as consignment goods?
There are three thoughts that may come into your mind during the audit of inventories involving consigned goods.
 Maybe not all the goods in the physical count belongs to the company concealing this fact to overstate
the ending inventories.
 Maybe the goods are not actually consigned out and the company only say this to conceal the missing
inventory from the site.
 Maybe the value of the consigned goods is not as it purports to be.
In order to clear the thoughts (or doubts) of the auditor and affirm the assertions of the management on the fairness
of its financial statements, here are the substantive procedures to guide the audit:
1. Inquire whether inventory is on consignment.
2. Confirm inventory held by others on consignment.
3. Inspect documents involving consignment.
4. Observe whether the consigned good is properly segregated and separately recorded.
The auditors will review the client’s disclosures of such matters to determine that they comply with Generally
Accepted Accounting Principles.
Summary of audit procedures classified per assertion
Applicable to Inventory
Assertion
Primary Audit Procedures
Category
✔ Inventory count observation and test counts
✔ Confirmation of inventories held by others
✔ Year-end inventory (purchase) cutoff
Existence ✔ Reconciliation of inventory summary sheet with general ledger
✔ Evaluate the client’s planning of physical inventory
✔ Obtain a copy of the completed physical inventory, test its clerical accuracy, and
trace test counts
✔ Reconciliation of inventory summary sheet with general ledger
Completeness ✔ Year-end inventory (purchase) cutoff
trace test counts

✔ Valuation in accordance with accounting policies
Valuation and ✔ Lower of cost or net realizable value test
Allocation ✔ Evaluate the client’s planning of physical inventory
trace test counts

Rights and
Obligations
trace test counts
Presentation and ✔ Valuation in accordance with accounting policies

Disclosure ✔ Lower of cost or net realizable value test
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Applicable to Cost of Sales / Purchases
Assertion
Primary Audit Procedures
Category
Occurrence ✔ Year-end inventory (purchase) cutoff
✔ Reconciliation of inventory summary sheet with general ledger

Accuracy
✔ Valuation in accordance with accounting policies
Cutoff ✔ Year-end inventory (purchase) cutoff
1. Analytical procedures for inventory

Analytical procedures are another substantive procedure in the audit of inventory and warehousing cycle.
Here are five procedures that may help you in your audit:
a. Compare gross margin percentage with that of previous years to see any overstatement or
understatement of inventory and cost of goods sold.
b. Compare inventory turnover (cost of goods sold divided by average inventory) with that of previous year
to determine any obsolete inventory overstatement or understatement of inventory.
c. Compare unit costs of inventory with those of previous years to determine any overstatement or
understatement of unit costs, which affect inventory and cost of goods sold
d. Compare current year manufacturing costs with those of previous years (variable costs should be
adjusted for changes in volume) to see if there are any possible misstatements of unit costs of inventory,
especially direct labor and manufacturing overhead, which affect inventory and cost of goods sold
e. Compare extended inventory value with that of previous years to determine any possible misstatements
in compilation, unit costs, or extensions, which affect inventory and cost of goods sold.
2. Determining existence of collateral agreements

Some businesses enter into loan agreements and use a variety of assets and/or equity items as a collateral for
such loans, and one of them is giving up inventory. This substantive procedure mainly satisfies the rights and obligations
assertion and tackles the issues:
a. Are there any inventory that are currently being held as collateral under debt agreements?
b. If there are any, who owns the inventory?
In order to respond in such issues and confirm the assertions, here are some procedures to guide the audit:
1. Inquire of management if inventory is being held on consignment or has been a security.
2. Examine loan agreements.
3. Examine purchases invoices to verify that inventory is owned rather than held on consignment.
4. Examine minutes of directors’ meetings for indications of inventory financing.
3. Reviewing purchase commitment agreements

In some business lines, it is required and customary for them to enter into purchase agreements, and some may
lead to losses especially if not protected by firm contracts. Since the record for purchase commitments are always
readily available, going greater lengths just to confirm such will just be a waste of time.
In reviewing these purchase agreements, the auditor may perform the ff.:
1. Check and compare commitment prices (quoted price against market value at balance sheet date)
2. Review quantities of purchase commitments.
4. Examining treatment of overheads in cost of inventories

The need for the management to evaluate the cost of overheads is sometimes considered to determine if such
costs are applied and/or allocated in accordance with the company’s policies, and discover any overstatements
influenced by fraud that can have an effect on the figures in the financial statements.
In such examination, the auditor may:
1. Verify the consistency of sources for overhead costs.
2. Compare amounts from sources to amounts actually reported in manufactured inventory.
3. Test the validity and consistency of method used in application of overheads.
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5. Evaluate financial statement presentation of inventories and cost of goods sold, including the adequacy
of disclosure
One of the most important factors in proper presentation of inventories in the financial statements is disclosure of
the inventory pricing method or methods in use. Other important disclosures include the following:
 Changes in method of valuing inventory
 The various classification of inventory
 Details of arrangements relating to any pledged inventory
 Deduction of valuation allowance for inventory losses.
 Existence and terms of inventory purchase commitments.
SITUATIONAL PROBLEM NO. 1 – JANNA Corporation .
TERESA, a senior manager manipulates the inventory of JANNA Corporation by understating it that will result
in an inflated net income. As a result, the cost of goods sold (COGS) will be overstated. That will result to
overstatement of gross profit margin, which will result to overstatement of income.
AR/Sales cutoff by getting entries from sales journal and vouching the supporting documents. Perform physical
count to determine whether inventories recorded are appropriately included or excluded.
SITUATIONAL PROBLEM NO. 2 – ABC .

ABC, a municipal government, ordered supplies (inventory for distribution) to EVIL Company (collusion) for
the construction of waiting shed in barangay DEF and GHI. EVIL issued a receipt while ABC recorded this in their
books as expense and issued documents substantiating the use of funds. ABC paid EVIL for a kickback.
Confirmation from the recipient of supplies to determine whether they have received the supplies.
SITUATIONAL PROBLEM NO. 3 – ResmarD .

Mariel, Angelica, Norlan and Gianne, both employees of ResmarD, a mushroom distributor, set up their own
company in direct competition with their employer. Starting December 2019, Mariel and Angelica made sales on
behalf of their own company, MANG Company, and then stole ResmarD’s inventory to complete the sale. To
conceal the theft, Norlan and Gianne enlisted the help of ResmarD’s inventory control specialist to manipulate
purchase order records and alter inventory records.
a. Analysis of AP
b. Vouching of prenumbered purchase order
SITUATIONAL PROBLEM NO. 4 – ResmarD .

Western Trading Company is a sole proprietorship engaged in the grain brokerage business. On December
31, 2019, the entire grain inventory of the company was stored in outside bonded warehouses. The company's
procedure of pricing inventories in these warehouses includes comparing the actual cost of each commodity in
inventory with the market price, as reported for transactions on the commodity exchanges on December 31. A
write-down is made on commodities in which cost is in excess of market. During the course of the 2019 audit, the
auditors verified the company's computations, and they compared the book value of the inventory with market
prices on February 15, 2020, the last day of fieldwork. The auditors noted that the market prices of several of the
commodities had declined sharply subsequent to year-end until their market price was significantly below the
commodities' book values.
The auditors re-priced the inventory based on the new market prices and found that the book value of the
inventory was higher than the market value on February 15 by approximately $21,000. The auditors proposed that
the inventories be written down by $17,000 to this new market value, net of gains on the subsequent sales. The
management protested this suggestion, stating that in their opinion the market decline was only temporary and
that prices would recover in the near future. They refused to allow the write-down to be made. Accordingly, the
auditors qualified their audit opinion for a departure from generally accepted accounting principles.
Were the auditors justified in issuing a qualified opinion for a departure from generally accepted accounting
principles?
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Based on the generally accepted accounting standards viewpoint, the auditors are right for letting the client
know about the proposed adjustments on the net realizable value of the inventories. Before the audit was done
and before the financial statements are authorized for issue, additional information about impairment of inventories
are available. This scenario produces a duty for the client to adjust the cost of their inventories. The impairment of
inventories being material leads to the auditor’s proposition of issuing a qualified opinion.
SITUATIONAL PROBLEM NO. 5 – C.T. Drug Stores .
C.T. Drug Stores counted its inventory on December 31, which is its fiscal year-end. The auditors observed
the count at 20 C.T.'s 86 locations. The company falsified the inventory at 20 of the locations not visited by the
auditors by including fictitious goods in the counts.
What auditing procedures could have detected the misstatement resulting from fraud or error?
The specific warehouses where counts will be observed should not be disclosed to employees or the
management of the client. Disclosing such information would lead to management to easily bypass the controls
and as well as test counts that are to be done by the auditors. Thus, the procedure done by the auditors are
rendered are susceptible to fraud by management.
PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – MarCo .

MarCo. is a wholesale distributor of automotive replacement parts. The entity provided the following information on
December 31, 2018.
Inventory on December 31 based on physical count P1,250,000.00
Accounts Payable 1,000,000.00
Sales 9,000,000.00
a. Parts held on consignment from another entity to MarCo, the consignee, amounting to P165,000, were included in
the physical count on December 31, 2018, and in accounts payable on December 31, 2018.
b. P20,000 of parts which were purchased and paid for in December 2018, were sold in the last week of 2018 and
appropriately recorded as sales of P28,000. The parts were included in the physical count on December 31, 2018
because the parts were on the loading dock waiting to be picked up by the customer.
c. Parts in transit on December 31, 2018 to customers, shipped FOB shipping point on December 28, 2018, amount
to P34,000. The customers received the parts on January 6, 2019.
d. Retailers were holding P210,000 at cost and P250,000 at retail, of goods on consignment from MarCo, at their
stores on December 31, 2018.
e. Goods were in transit from a vendor to MarCo on December 31, 2018. The cost of goods was P25,000. The goods
were shipped FOB shipping point on December 29, 2018.
Questions:
1. What is the correct amount of inventory?
2. What is the correct amount of accounts payable?
3. What is the correct amount of sales?
Suggested Solution:
INVENTORY ACCOUNTS PAYABLE SALES
Unadjusted P1,250,000.00 P1,000,000.00 P9,000,000.00
a (165,000.00) (165,000.00) -
b (20,000.00) - -
c - - 40,000.00
d 210,000.00 - -
e 25,000.00 25,000.00 -
Adjusted 1.) P 1,300,000.00 2.) P860,000.00 3.) P9,040,000.00
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PRACTICAL PROBLEM NO. 2 – JayDee Company .
JayDee Company is in the process of auditing its financial statements for the year 2019 but due to fire on the production
department, some of the information cannot be obtained except for direct materials issued to production, P400,000 and
Finished goods from last year, P140,000.
The auditor observed the following using the previous financial statements of JayDee Company:
a. Direct labor is applied at 50% of direct materials and factory overhead costs are applied at 75% of direct labor.
b. Work-in-process is maintained at 25% more than the previous work-in-process.
c. Finished goods inventory is 20% less than the finished goods inventory from the previous year.
d. Mark up of 25% on cost is added to derive sales. Net sales is recorded properly as:
Gross Sales P690,000.00
Less: Sales Returns (30,000.00)
Sales Discounts (15,000.00)
Net Sales P645,000.00
Questions:
Determine the estimated value of:
1. WIP, end
2. Finished goods, end
3. Cost of sales
Suggested Solution:
Direct Materials(given) P400,000.00
Add: Direct labor (50% x 400,000) 200,000.00
Factory Overhead (75% x 200,000) 150,000.00
Total Cost of Manufacturing P750,000.00
Add: WIP, beginning (X)* 1,000,000.00
Total Goods held in Production P1,750,000.00
Less: 1.) WIP, end (X × 125%) * (1,250,000.00)
Total cost of goods manufactured P500,000.00
Add: Finished goods, beginning (given, Y) 140,000.00
Total goods available for sale P640,000.00
Less: 2.) Finished goods, end (Y x 80%) (112,000.00)
3.) Cost of sales ((690,000 - 30,000)/125%) ** P528,000.00
Notes:
*The difference between total manufacturing cost and total cost of goods manufactured is the 25% difference between
the WIP, beg and WIP, end.
**There is no physical transfer of inventory in sales discounts, therefore, only sales returns are deducted from gross
sales to get the cost of goods sold.
PRACTICAL PROBLEM NO. 3 – Ivy Inc. .

In your audit of the December 31, 2014 financial statements of Ivy Inc., you found the following inventory related
transactions:
a. Goods costing P100,000 are on consignment with a customer. These goods were invoiced at normal profit margin
which was at 40% based on cost and was recorded as 2014 sales. Being offsite on the count date which was on
December 30, 2013, the goods were not included in the physical count.
b. Goods costing P33,000 were delivered to Ivy Inc. on January 4, 2015. The invoice of these goods was received
and recorded on January 10, 2015. The invoice showed the shipment was made on December 29, 2014, FOB
shipping point.
c. Goods costing P40,000 were shipped FOB shipping point on December 31, 2014 and were received by the
customer on January 2, 2015. Although sale was recorded in 2014, these goods were included in the 2014
inventory.
d. Goods costing P16,000 were shipped to a customer on December 30, 2014, FOB destination. These goods were
received by the customer on January 5, 2015 and were not included in the physical count. The sale was properly
recorded in 2015.
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e. Goods costing P22,000 shipped by a vendor under FOB destination term, were received on January 3, 2015. The
related invoice however, were received on December 31, 2014, thus was recorded as purchase in 2014.
f. Goods costing P50,000 were received from a vendor under consignment term. These goods were included in the
physical count. No purchase related to the inventory had been recorded yet.
g. Ivy Inc., recorded as 2014 sale a P112,000 invoice for goods delivered to a customer on December 31, 2014, FOB
Destination. The goods were received by the customer on January 5, 2015. Having been delivered after the count
date, the goods were included in the physical count.
Questions:
1. Net adjustment to inventories as of December 31, 2014
2. Net adjustment to accounts receivable as of December 31, 2014 (assuming all sales are on account)
3. Net adjustment to accounts payable (assuming all purchases are on account)
4. Effect of the errors to the 2014 net income.
Suggested Solution:
Inventory A/R A/P Sales Purchase Net income
a P100,000.00 (P140,000.00) - (P140,000.00) - (P40,000.00)
b 33,000.00 - P33,000.00 - P33,000.00 -
c (40,000.00) - - - - (40,000.00)
d 16,000.00 - - - - 16,000.00
e - - (22,000.00) - (22,000.00) 22,000.00
f (50,000.00) - - - - (50,000.00)
g (112,000.00) - (112,000.00) - (112,000.00)
Net Effect 1.) P59,000.00 2.) (P252,000.00) 3.) P11,000.00 (P252,000.00) P11,000.00 4.)
(P240,000.00)
PRACTICAL PROBLEM NO. 4 – Akihito Co. .

You are making an audit of the Akihito Co. for the year ended December 31, 2014. You have observed the taking of
physical inventory and have noted that all merchandise actually received up to the close of business, December 28,
2014, were included on the inventory sheets. The total of the physical inventory, at invoice cost, is ₱175,000, while the
purchase account shows a balance of ₱1,750,000 as of December 31, 2014.
You noted the following purchases invoices have been recorded in the voucher register as follows:
RR. December 2014 Invoice Date Terms Merchandise

No. Voucher Register Received
631 ₱2,000 December 26 Shipping Point December 29

632 4,000 December 26 Destination January 5
633 9,000 January 2 Destination December 30
634 8,000 December 31 Shipping Point January 4
635 1,000 January 7 Shipping Point December 28
636 6,000 January 3 Shipping Point January 6
RR. January 2014 Invoice Date Terms Merchandise

No. Voucher Register Received
637 ₱8,500 December 20 Destination January 8
638 7,200 January 2 Shipping Point December 27
641 4,100 January 2 Destination December 25
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Questions:
1. What is the adjusted balance of Purchases for the period ended December 31, 2014?
2. What is the adjusted balance of the Inventory account as of December 31, 2014?
Suggested Solution:
RR. No. Purchases Inventory
Unadjusted ₱1,750,000.00 ₱175,000.00
631 - 2,000.00
632 (4,000.00) -
633 - 9,000.00
634 - 8,000.00
635 - -
636 (6,000.00) -
637 - -
638 7,200.00 -
639 - -
640 - -
641 4,100.00 -
Adjusted 1.) P1,751,300.00 2.) P194,000.00
Notes:
a. For purchase:
No. 632 is on FOB Destination and received on January 5, 2015. Therefore, it should not have been
recorded as purchase.
No. 636 is on FOB Shipping point. Although, invoice was dated January 3, 2015 and the goods were
received on January 6, 2015 so they should not be included in the 2014 purchases.
b. For inventory:
No. 631 and 634 were on FOB Shipping point dated December 26, 2014 and December 31, 2014, respectively.
They were not included in the December 28 physical count yet they should be. No. 633, although it was on FOB
Destination, it was received on December 30, 2014 which was not included in the December 28 physical count, yet it
should be included in the ending inventory.
PRACTICAL PROBLEM NO. 5 – Tetsuya Kuro Co. .

Tetsuya Kuro Co. is a manufacturer of basic calculators supplying bookstores and school supplies shops. According to
Tetsuya Kuro Co.’s management, there are no changes in production costs for the past 5 years and that the unit cost
of the goods is ₱525. You, the auditor, obtained information from Tetsuya Kuro Co.’s financial statements for 4 years
as follows:
Ending Inventory Units Produced Sold
2016 P588,000.00 1120
2017 619,500.00 1180 320 260
2018 577,500.00 1100 215 295
2019 676,500.00 ? 380 250
During the physical count, you have observed that the goods in the ending inventory are 1,220 units. Adjustments have
also been made by Tetsuya Kuro Co. except for the damaged goods which is not reflected in the 2019 financial
statements but already taken account for in the physical count.
You suspect that other than the inventory loss, the overstatement(understatement) of inventory is due to the unit cost
used by Tetsuya Kuro Co.’s accountant in deriving ending inventory.
Questions:
1. How many units are reflected in the 2019 financial statements and how many damaged units that over(under)states
the inventory in units?
2. What is the overstatement(understatement) of the 2019 ending inventory?
3. What is the unit cost used by Tetsuya Kuro Co.’s accountant?
4. What is the effect of the inventory loss on Tetsuya Kuro Co.’s net income?
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Beginning inventory 1,100
Add: Produced Units 380
Less: Sold Units (250)
Ending inventory (Unadjusted) 1,230
Misstatement of inventory (SQUEEZE) (10)
1.) Adjusted inventory (Physical count) 1,220
Recorded ending inventory 2019 ₱676,000.00

Adjusted value of ending inventory 2019 (1,220 x 525) (640,500.00)
2.) Overstatement P36,000.00
3.) Unadjusted ending inventory P676,500 / 1,230 = ₱550.00 per unit
4.) Inventory loss: 10 units x P525 = P5,250

The loss on inventory is considered normal and immaterial, and should be closed to the cost of sales.
The cost of sales is understated by P5,250 therefore, net income is overstated by ₱5,250.00.
PRACTICAL PROBLEM NO. 6 – ABS-CBN Corporation .

After a preliminary understanding and corresponding test of controls of the client’s internal control over ABS-CBN
Corporation’s inventory, you have assessed the control risk at below maximum level. As a result, you decided to
observe the inventory count procedure at an interim date rather than at the balance sheet date. The client scheduled
the inventory count on October 31, 2020.
The following information were deemed relevant in relation to your audit:
Inventory, January 1, 2020 ₱355,600.00
Inventory, October 31, 2020 as a result of the count 542,300.00
Purchases from January 1 to October 31 per books 4,265,500.00
Purchases from January 1 to December 31 per books 5,760,500.00
Sales from January 1 to October 31 per books 6,408,000.00
Sales from January 1 to December 31 per books 9,149,908.00
Audit notes:
a. Goods received from a supplier costing ₱54,000 on October 30, 2020 was recorded as PURCHASES in
November.
b. Goods received from a supplier costing ₱67,900 on November 2, 2020 was recorded as PURCHASES in
October. Further investigations revealed that these were in transit under FOB Destination term as of October
31, the count date.
c. Advanced payments amounting to ₱80,500 to suppliers in October were recorded as PURCHASES in October.
The goods were however received only in November.
d. Advanced payments amounting to ₱112,400 to suppliers in December were recorded as PURCHASES in
December. The goods however were received only in January of the following year.
e. Errors in inventory summary as a result of the physical count amounted to ₱20,600 overstatement.
f. Damaged inventories were sold in December at their cost amounting to ₱80,500.
Questions:
1. Gross profit rate based on sales for the ten months ended October 31, 2020.
2. Cost of sales ended December 31, 2020.
3. Estimated inventory as of December 31, 2020.
Sales (10 Months) P6,408,000.00 100%
Cost Of Sales:
Inventory, Jan. 1 P 355,600.00
*Net Purchases (10 Months) 4,171,100.00
COGAFS 4,526,000.00
**Inventory, Oct. 31 (521,700.00) (4,005,000.00) 62.5%
Gross Profit P2,403,000.00 1.) 37.5%
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Adjustments in response to audit notes:
*PURCHASES (10 PURCHASES (12 **INVENTORY,
MONTHS) MONTHS) OCT. 31
Balances ₱4,265,500.00 ₱5,760,500.00 ₱542,300.00
Valid Oct. Purchase Recorded In 54,000.00
Nov.
Oct. Purchase In Transit Fob (67,900.00)
Shipping Point
Oct. Advances To Suppliers (80,500.00)
Dec. Advances To Suppliers (112,400.00)
Inventory Summary Error (20,600.00)
Adjusted Balances P4,171,10.000 P5,648,100.00 P521,700.00
Gross Sales, 12 Months ₱9,149,908.00
Sale of Damaged Goods (80,500.00)
Sales With 37.5% GP Rate P9,069,408.00
Multiply by Cost Rate 62.5%
Cost of Sales – Sales with 37.5% GP Rate P5,668,380.00
Sale of Damaged Goods 80,500.00
Total Cost of Sales 2.) P5,748,880.00
Inventory, Jan.1, 2020 P 355,600.00
Net Purchases for 12 Months 5,648,100.00
COGAFS for 12 Months P6,003,700.00
COGS (5,748,880.00)
Inventory, Dec. 31, 2020 3.) P254,820.00
PRACTICAL PROBLEM NO. 7 – The Great Gatsby Mfg .

Nick Carraway, the senior audit associate in charge of the audit of The Great Gatsby Mfg. observed the client’s physical
inventory count held on the last day of the company’s fiscal year, August 31, 2020.
The results of the test counts are listed below:
TEST CLIENT AUDITOR’S
INVENTORY AUDIT
COUNT INVENTORY TEST VARIANCE EXPLANATION
ITEM RESPONSE
NUMBER QUANTITY COUNT
Inventory in transit
shipped FOB
1 TB-6123 484 434 (50) Shipping Point, ?
received
September 2
Inventory sold to
customer FOB
Destination; not
2 DF-0990 11,222 11,000 (222) ?
received by
customer until
September 2
Payments made in
advance for items
3 MW-8013 203 197 (6) ?
received
September 3
Inventory received
August 30; vendor
4 MW-8012 786 800 14 ?
shipment receipt
not recorded
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Inventory was
separated for a
5 JB-5491 663 600 (63) September 1 sale; ?
held on dock for
customer pickup
Additional items
identified as
6 GJ-6403 127 150 23 damaged and will ?
be returned to
vendor
The following are the suggested audit responses for each test count:
a. Obtain the scrap inventory log ang agree to general ledger.
b. Review return shipment documentation to verify exclusion from inventory count.
c. Review return shipment documentation to verify inclusion in inventory count.
d. Inspect supporting purchase documents for proper shipping terms and receiving information to verify inclusion
in inventory count.
e. Inspect supporting purchase documents for proper shipping terms and receiving information to verify exclusion
from inventory count.
f. Request that client make appropriate correction to record additional inventory.
g. Request that client make appropriate correction to reduce additional inventory.
h. Inspect supporting documents and agree quantities received to purchase order.
i. Inspect supporting sale and shipment documentation for proper shipping terms for exclusion from inventory
account.
j. Inspect supporting sale and shipment documentation for proper shipping terms for inclusion in inventory account
Requirement:
1. Supply the boxes with the appropriate audit response.
Suggested Answers:
Test count No. 1
in inventory count.
In this test count, the auditor's test count quantity was less than the inventory quantity per client records. The
client's explanation was that it included in its records inventory that was shipped FOB shipping point, which was
received on September 2. This explanation indicates that it is a purchase of inventory because the client received
inventory. Items purchased with FOB shipping-point terms require the client to record the items as inventory as
soon as the vendor ships the inventory. Therefore, the auditor should inspect supporting documents to support the
client's explanation. Specifically, the auditor should verify proper shipping terms (that it is FOB shipping point) and
receiving information (verify number of items received) to verify the amount to be included in the inventory count.
Test count No. 2
j. Inspect supporting sale and shipment documentation for proper shipping terms for inclusion in inventory count.
In this test count, the auditor's test count quantity was less than the inventory quantity per client records.
The client's explanation was that the inventory was sold to a customer FOB destination and was not received
by the customer until September 2. Inventory sold means that this is a sale of inventory. Items shipped FOB
destination require the client to record the sale and relief of inventory when the item has reached its destination.
In this case, the sale and relief of inventory will be recorded on September 2 (after fiscal year-end). Therefore, the
auditor should inspect supporting documents to corroborate the client's explanation. Specifically, the auditor should
inspect supporting sale and shipment documentation for inclusion of these items in the inventory count.
Test count No. 3
in inventory count.
explanation provided was that payments were made in advance for items received September 3. This transaction
relates to a purchase transaction because the client is paying for items. The auditor needs to verify that the items
should be included in the count (i.e. verify the items were shipped FOB shipping point and were shipped prior to
or on August 30). The auditor should inspect supporting purchase documents for proper shipping terms and
receiving information to verify inclusion in the inventory count.
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Test count No. 4
f. Request that client make appropriate correction to record additional inventory.
In this test count, the auditor's test count quantity was more than the inventory quantity per client records. The
explanation provided was that inventory was received on August 30, but the vendor shipment receipt was not
recorded. Inventory received prior to year-end needs to be included in the inventory count. Therefore, the auditor
should request that the client make an adjusting journal entry to record the additional inventory.
Test count No. 5
j. Inspect supporting sale and shipment documentation for proper shipping terms for inclusion in inventory count.
explanation provided was that inventory was separated for a September 1 sale (after fiscal year-end) and was held
on dock for customer pickup. The items should be included in the count as of August 30 because this sale is after
year-end. Therefore, the auditor should inspect supporting sale and shipping documentation for proper shipping
terms (which would say customer pickup) for inclusion in the inventory count.
Test count No. 6
b. Review return shipment documentation to verify exclusion from inventory count.
In this test count, the auditor's test count was more than the inventory quantity per client records. The
explanation provided was that additional items were identified as damaged and will be returned to the vendor.
Therefore, the auditor should review the return shipment documentation to verify that this inventory should be
excluded from the inventory count.
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OUTLINE
1. Introduction
1.1 Quick review: Purpose of Investments
1.2 Audit of Investments in a nutshell

2.1 Management Assertion: Existence and Rights
2.2 Management Assertion: Completeness
2.3 Management Assertion: Occurrence and Valuation and Allocation

3.1 Management Assertion: Accuracy
3.2 Management Assertion: Classification
3.3 Management Assertion: Presentation and Disclosure
3.4 Management Representation
3.5 Documentation
4. Situational problems
4.1 ABC Ltd. – Valuation Assertion
4.2 PMO Co. – Existence & Rights and Obligations Assertions
4.3 YG Inc. – Completeness & Accuracy Assertions
4.4 WorldCom – Presentation and Disclosure & Existence Assertions
4.5 SMV Company – Valuation Assertion
5.1 Bato Company
5.2 Leo Corporation
5.3 MILLAN Inc.
5.4 Corgi Corp.
5.5 BARBIE Corporation
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AUDIT OF INVESTMENTS
Introduction
Investment is an asset held by an entity for purposes of accretion of wealth through distributions of dividends,
interest and rentals or for capital appreciation or other benefits to be obtained.
Investments are presented either as ‘current investments’ and ‘long-term investments.’ A current investment
is an investment that is by its nature readily realizable and is intended to be held for not more than one year from the
date on which such investment is made. A Long-term investment is an investment other than a current investment.
Quick review: Purpose of Investments
Investment Purpose
 Investment in Equity Instruments – To earn from changes in fair value and dividends
Financial Asset at fair value
 Investment in Equity Instruments – To benefit from exercising significant influence over
Associate another entity
 Investment in Equity Instruments – To benefit from exercising control over another entity
Subsidiary
 Investment in Equity Instruments – Joint To benefit from exercising joint control over another
Venture entity
 Investment in Debt Investments To earn from changes in fair value and interest
 Investment in special purpose funds To accumulate funds for basically any purpose such as
plant expansion and long-term debt retirement
 Investment in Derivatives To earn from changes in fair value

 Investment in life Insurance policies – Cash To compensate the entity from the untimely death of key
surrender value officers
Audit of Investments in a nutshell:

1. Understand the Client’s investing activities
The complexity of auditing entity’s investments always going to be different because for entities with simple
investment instruments, auditing does not require much tedious work. One of the primary audit procedures might
be to confirm its existence.
Under other conditions, complex investments or entities with large investment portfolio, however, require
additional work such as auditing values. As investment complexity increases, so will the need for more highly
competent audit team members (those that can thoroughly understand unusual investments).
Inherent Risk Assessment
The inherent risk for an assertion about an investment is its susceptibility to a material misstatement,
assuming there are no related controls. Factors that might affect the auditor's assessment of inherent
risk for assertions about an investment include the following:
 The complexity of the features of the investment.
 Whether external factors affect the assertion.
2. Internal Control Evaluation
The auditor should carefully evaluate and study the system of internal control for audit clients that have large
investment portfolio to determine the nature, timing and extent of audit procedures. Since it has several
investments related transactions, the auditor should decide whether it would be more efficient to conduct test of
control before substantive test. Before he opts to decide to rely on test of control, the auditor should ascertain the
following internal control regarding investments:
 Control over acquisition, accretion and disposal of investments
 Safeguarding of investments
 Controls relating to title to investments
 Information controls
Control Risk Assessment
After obtaining the understanding of internal control over investment transactions, the auditor should
assess control risk for the related assertions. If the auditor plans to assess control risk at less than
maximum for one or more assertions regarding investments, the auditor should identify specific controls
relevant to the assertions that are likely to prevent or detect material misstatements and gather audit
evidence about their operating effectiveness.
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The auditor should use the assessed levels of inherent risk and control risk for assertions about investments
to determine the nature, timing, and extent of the substantive procedures to be performed to detect material
misstatements of the financial statement assertions. Some substantive procedures address more than one assertion
about various investment transactions.
 Management Assertion: Existence and Rights

Audit Objectives:
 All recorded investments in the statement of financial position exist.
 The entity owns, or has legal right to the investments included on the statement of financial position.
Audit Procedures:
The auditor’s procedure depends whether the securities or evidence of ownership are held by the client or
third party.
 If the securities or evidence of ownership is held by the client, the auditor counts the securities or
instruments on hand with simultaneous count of cash and other negotiable instrument to prevent
substitution.
 If held by third party, the auditor will confirm to the custodian or arrange for a visit to the custodian
and conduct a count.
 For investment properties, arrange for an ocular inspection of investment properties and trace back
acquisition of investment properties to acquisition documents.
Documents/Files needed:
 Stock certificates
 Confirmation letter1
 Deed of sale and other title transfer papers
 Management Assertion: Completeness

Audit Objectives:
 To determine that investments to which the company has title to are all included in the statement of
financial position.
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Audit Procedures:
 Trace selected purchases and sales of securities and other investments during the year.
 Inspect securities on hand.
 Obtain confirmation of securities held by others.
Document/Files needed:
 Stock certificates
 Deed of sale and other title transfer papers
 BOD’s minutes of meeting
 Management Assertion: Occurrence and Valuation and Allocation
Audit Objectives:
 All recorded income from investments has accrued to the entity at the reporting date.
 To determine that investments are valued properly in accordance with applicable PFRS.
Audit Procedures:
 The Accounting method and impairment test on investments of the client depends on the applicable
PFRS. Therefore, the procedure applied by the auditor depends on the type of investment.
Accounting Classification of
Level of Influence % of ownership Applicable PFRS
Method Investment
PFRS 9
Financial asset at
Little or none <20% Fair Value PFRS 7
fair value
PAS 32
Investment in
Significant 20-50% Equity PAS 28
Associate
Investment in
Control >50% Consolidation PFRS 10
Subsidiary
No quantitative Investment in Joint

Joint Control Equity PAS 28
presumption Venture
For Investment under Fair value method:

The auditor should examine whether at initial measurement, in computing the cost directly
attributable to investments, has been expensed outright (for FA-FVTPL) or was capitalized in the cost
of investments (FA-FVOCI) – In accordance with Application Guidance of PFRS 9.
The auditor should ascertain the fair value of the quoted securities from official quotations of the
Philippine Stock Exchange. And in case of unquoted securities, the auditor should ascertain if it was
measured in accordance with Application Guidance B5.4.14 of PFRS 9 (For FA@FV). In which, equity
instruments must be measured at fair value and at cost in case fair value cannot reliably measured.
For Investment under Equity Method:
The auditor should verify the share in net income or loss by examining the audited financial statement
of the investee and making independent calculation. For dividends received, the auditor can examine
published dividend record of the investee.
For Investment under Consolidation:
The auditor should verify the beginning balance of the investment for the current year, the auditor
will normally refer to its prior working paper. The auditor will also examine any addition or disposal by
examining supporting documentation.
Test Impairments of Investment
Test of Impairment will also depend on the applicable PFRS which is to be considered by the auditor
in evaluating the impairment made by the management. The auditor should also inquire with the
management in their methods in identifying impairment.
Document/Files needed:
 Audited financial statement of investee
 PSE quotations
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 Management Assertion: Accuracy

Audit Objective:
 Amounts and other data relating to recorded transactions and events have been recorded
appropriately.
Audit Procedures:
 Evaluating the accounting methods used and test the valuation.
 Investigating current and potential impairments of investments.
o Inquire with management their approach in identifying indicators of impairment, and the actions
taken as a result of any potential impairment noted.
o Evaluate the appropriateness of the valuation model and assumptions used.
o Assess the reasonableness of management’s estimates.
o Evaluate the accuracy, completeness, and relevance of the important data on which the
estimates or measurements are based.
 Audited Financial Statement of Investee
 Management Assertion: Classification

Audit Objective:
 Income statement related items are appropriately recorded in the proper accounts in the statement
of comprehensive income.
Audit Procedures:
 Reviewing appropriateness of presentation and adequacy of disclosure of investments including
related account.
 Discuss with the entity the process used by management in classifying its investments.
 Management Assertion: Presentation & Disclosure

Audit Objectives:
 Investments and related investment income accounts are properly classified, described, and
disclosed in the financial statements, including notes, in accordance with the applicable PFRS.
 All investment pledged or other security interests are adequately and properly disclosed.
Audit Procedures:
 Reviewing board of directors’ (BOD) minutes of meetings, shareholders meeting, committee
meetings and agreements and confirmation replies.
o Gather evidence regarding authorization, liens, and pledges.
o Disclose unrecorded purchases and sales of securities or other financial instruments.
 Reviewing appropriateness of presentation and adequacy of disclosure of investments including
related account.
o Determine the applicable PFRS in the proper classification and presentation of investments in
the statement of financial position and necessary disclosures.
o Determine that the related income statement accounts are correctly recorded in profit or loss or
as a component of other comprehensive income.
 Minutes of BOD meeting
 Other evidence to determine current value of investments
 Management Representations
The auditor should obtain from the management of the entity a written statement regarding classification and
valuation of investments for Balance Sheet purposes. While such a representation letter serves as a formal
acknowledgment of the management's responsibilities with regard to investments, it does not relieve the auditor of his
responsibility for performing audit procedures to obtain sufficient appropriate audit evidence to form the basis for the
expression of his opinion on the financial information.
It may be mentioned that the representations made in the letter can alternatively be included in the composite
representation letter usually issued by the management to the auditor.
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 Documentation
The auditor should maintain adequate working papers regarding audit of investments. Among others, he
should maintain on his audit file, the management representation letter concerning investments.
SITUATIONAL PROBLEM NO. 1 – ABC Ltd. .

ABC Ltd. has a material investment in XYZ Co., a foreign subsidiary whose net worth has been
fully/substantially eroded. The management has not provided any evidence of how they valued the investment to
conclude on the carrying amount. The auditor was also unable to obtain sufficient appropriate audit evidence about
the carrying amount of ABC Ltd.’s investment in XYZ Co. as at 31st March 20XX, because they were denied access
to the financial information, management & the auditors of XYZ Co., due to the collision between the two entities.
There is an issue on the valuation assertion of the investments of the ABC Ltd., since there is uncertainty as
to how the management had come up with the carrying amount of its investments in the XYZ Co. Assertions about
the valuation of investments address whether the amounts reported in the financial statements through
measurement or disclosure were determined in conformity with generally accepted accounting principles (GAAP),
to which in this case, it cannot be determined since there are limitations on the data that the auditor can access.
Tests of valuation assertions should be designed according to the valuation method used for the measurement
or disclosure. The GAAP may require that an instrument be valued based on cost, the investee's financial results,
or fair value. Also, the GAAP for securities may vary depending on the type of security, the nature of the transaction,
management's objectives related to the security, and the type of entity.
What the auditor may do is to seek the financial statements readily available in the website of the Securities
and Exchange Commission (SEC), so that he may study the financial status of the XYZ Co. to see if the
investments of the ABC Ltd. are properly valued. He may also see the quotations in the active market for the like
investments as reference.
SITUATIONAL PROBLEM NO. 2 – PMO Co. .

Justin, the investment custodian of PMO Co., stole more than $2 Million from the company to finance his
gambling addiction, as well as to pay for his rent and his car. To cover up for his theft, he manipulated the statement
of financial position of the company by intentionally overstating its assets by increasing the investments presented.
There is an issue on the existence and rights and obligations assertions over the investments as there are
investments that may not exist, or could have existed but the company may not have the rights over, as at year-
end due to the intentional overstatement made by the investment custodian to cover up for his theft. The existence
assertion addresses whether the investments reported in the financial statements through recognition or disclosure
exist at the date of the statement of financial position.
Since he made these overstatements, he may present files to support his claims, so the auditor may perform
measures to confirm his claims.
He may choose among the following procedures to ascertain the existence assertion such as doing a physical
inspection of the investment contracts and vouching these, doing a bank confirmation for investments held as
mortgage or safe custody, doing a confirmation with the issuer of the securities and ask if there are indeed
investments made by the company and if how much is the investment, or by doing a confirmation of the settled,
as well as the unsettled, transactions with the broker-dealer or its counterparty.
Also, it is always a good idea to check the minutes of the corporate meetings to confirm the authorization to
purchase and sell each investment, as these matters are always written in the minutes.
SITUATIONAL PROBLEM NO. 3 – YG Inc. .

Sandy is auditing the financial statements of YG Inc. for the year ended 20x8. As a result of her audit, she
found out that there are some investments and investment-related income accounts that were omitted from the
general ledger by the investment custodian.
She has confirmed that not all investment-related interest and dividend income has hit the income statement
as revenue and that some investment income hitting the income statement can’t be matched to an investment,
which means that not all investments are reflecting on the balance sheet.
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The issue lies in the completeness and accuracy assertions the company had over its recorded investments.
Completeness assertion addresses whether all of the entity's derivatives and securities are reported in the financial
statements through recognition or disclosure. They also address whether all investment-related transactions are
reported in the financial statements as a part of earnings, other comprehensive income, or cash flows or through
disclosure.
To test a client’s investments, auditors mostly look at how a security is categorized and whether it’s presented
on the client’s income statement or balance sheet.
The accuracy assertion states that all information disclosed are in the correct amounts, and reflect their proper
values. Since there are some values that cannot be matched to any investment account, there is an issue on the
company’s assertion on the accuracy of its recorded investments.
The auditor may opt to calculate expected income with reference to supporting documents and compare them
with the recorded income. She may also obtain or prepare a lead schedule of investments, and trace last year’s
balances with last year’s working papers, check arithmetical accuracy of the schedule and trace totals of the
schedule to general ledger control account and balance sheet. Comparing previous and current account detail may
also help to identify the assets that have been removed from the accounts and testing those items further to
determine that the criteria for sales treatment have been met.
She may also do a confirmation with the issuers of the investment items, to know if there really an investment
that exists and if there is, how much is it.
She also may opt to do an inspection of the entries in investments and related income accounts. She may
check additions and sales, inspect board of directors minutes for authorization of sales and purchases of
investments, or re-compute gain or loss on sale of investments, if any.
SITUATIONAL PROBLEM NO. 4 – WorldCom .

WorldCom recorded operating expenses as investments. Apparently, the company felt that office pens,
pencils, and paper were an investment in the future of the company and, therefore, capitalized the cost of these
items over a number of years. In total, $3.8 billion worth of normal operating expenses, which should all be recorded
as expenses for the fiscal year in which they were incurred, were treated as investments and were recorded over
a number of years. This little accounting trick grossly exaggerated profits for the year the expenses were incurred.
Assertions about presentation and disclosure address whether the classification, description, and disclosure
of the investments in the entity's financial statements are in conformity with generally accepted accounting
principles. The issue here is that the company has recorded the supposedly operating expenses as investments,
which will result into the overstatement of its reported investment.
In evaluating the adequacy of presentation and disclosure, the auditor should consider the form, arrangement,
and content of the financial statements and their notes, including, for example, the terminology used, the amount
of detail given, the classification of items in the statements, and the bases of amounts reported.
What the auditor may opt to do is to check the disclosures written in the notes to the financial statements of
the company and see how the company has presented the investments, as the breakdown for the investments are
usually disclosed in there.
SITUATIONAL PROBLEM NO. 5 – SMV Company .

The financial statements of SMV Co. for the year 20xA has been audited by Russel. During the course of his
audit, he found out that some of the investments of the company are improperly valued due to their complexity and
management’s lack of accounting knowledge in recording and classifying them. The auditor is thinking of hiring an
investment specialist to value these investments.
What the auditor may opt to do instead of hiring an investment specialist to classify and value these
investments is to rather check all of the documents and information available, and re-compute for the amount of
the investment, as hiring one can just add to the cost of the company. If the amount computed reconciles with the
amount recorded, it means that the investments are complete.
For the valuation assertion to be addressed, the auditor may refer to the quotations in the market to see how
these investments are currently valued.
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PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – Bato Company .
You were engaged by Bato Company to audit its financial statements for the year 2019. During the course of your
audit, you noted that the following trading securities were properly reported as current assets at December 31, 2018:
Cost Market
France Corporation, 5,000 shares,
convertible preferred shares P 450,000.00 P 487,500.00
Ces, Inc., 30,000 shares of common stock 675,000.00 742,500.00
Coo Co., 10,000 shares of common stock 618,750.00 450,000.00
P1,743,750.00 P1,680,000.00
The following sale and conversion transactions transpired during 2019:
Mar. 1 Sold 12,500 shares of Ces for P33.75 per share.
April 1 Sold 2,500 shares of Coo for P45.00 per share.
Sept. 21 Converted 2,500 shares of France’s preferred stock into 7,500

shares of France’s common stock, when the market price was
P78.75 per share for the preferred stock and P47.25 per share for
the common stock.
The following 2019 dividend information pertains to stocks owned by Bato:
Jan. 2 Coo issued a 10% stock dividend when the market price of Coo’s
common stock was P49.50 per share.
March 31 and France paid dividends of P2.50 per share on its preferred stock, to
Sept. 30 stockholders of record on March 15 and September 15, respectively.
France did not pay dividends on its common stock during 2006.
July 1 Ces paid a P2.25 per share dividend on its common stock.
Market prices per share of the securities were as follows:
12/31/2019 12/31/2018
France Corp., preferred 92.25 97.50
France Corp., common 42.75 38.25
Ces, Inc., common 22.50 24.75
Coo Co., common 40.50 45.00
All of the foregoing stocks are listed in the Philippine Stock Exchange. Declines in market value from cost would not be
considered permanent.
Questions:
1. How much is the gain or loss on conversion of 2,500 France preferred stock into 15,000 common stock?
2. How much should be reported as unrealized gain on trading securities in the company’s income statement for the
year 2019?
Fair value of preferred stock (2,500 shares x P78.75) P196,875.00

Less: CV of shares converted (P487,500 x 2.5/5) (243,750.00)
1.) Loss on conversion of 2,500 France preferred shares P 46,875.00
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Trading securities, 1/1/19 P1,680,000.00
Less: CV of Ces shares sold (309,375.00)
CV of Coo shares sold (102,273.00)
CV of France preferred shares converted (243,750.00)
Add: Cost of 7,500 France common shares received 196,875.00
Trading securities, 12/31/19 before mark-to-market P1,221,477.00
Less: Fair value of trading securities, 12/31/19* (1,289,250.00)
2.) Unrealized gain on trading securities P 67,773.00
France Corp., preferred [(5,000 - 2,500) x P92.25] P 230,625.00

France Corp. – Common (7,500 x P42.75) 320,625.00
Ces, Inc., common [(30,000 - 12,500) x P22.50] 393,750.00
Coo Co., common {[(10,000 x 1.1) - 2,500] x P40.50} 344,250.00
*Fair value of trading securities, 12/31/19 P1,289,250.00
PRACTICAL PROBLEM NO. 2 – Leo Corporation .
On June 1, 2019, Leo Corporation purchased as a long term investment 4,000 of the P1,000 face value, 8% bonds of
Angela Corporation. The bonds were purchased to yield 10% interest. Interest is payable semi-annually on December
1 and June 1. The bonds mature on June 1, 2025.Leo uses the effective interest method of amortization. On November
1, 2020, Leo sold the bonds for a total consideration of P3,925,000. Leo intended to hold these bonds until they matured,
so year-to-year market fluctuations were ignored in accounting for bonds.
Questions:
1. The carrying value of the investment in bonds as of December 31, 2019
2. The interest income for the year 2020
3. The gain on sale of investment in bonds on November 1, 2020
4. The carrying value of the investment in bonds as of November 1, 2020
Carrying value, 6/1/19 P3,645,328.00

Add: Discount amortization, 6/1/19 to 11/30/19:
Effective interest (P3,645,468 x 10% x 6/12) P182,266.00
Nominal interest (P4,000,000 x 8% x 6/12) (160,000.00) 22,266.00
Carrying value, 12/1/19 P3,667,594.00
PV of principal (P4,000,000 x 0.5568) P2,227,200.00

PV of interest [(P4,000,000 x 4%) x 8.8633] 1,418,128.00
Purchase price P3,645,328.00
Carrying value, 12/1/19 P3,667,594.00

Add: Discount amortization, 12/1/19 to
12/31/19:
Effective interest (P3,667,594 x 10% x P30,563.00
1/12)
1.) Carrying value, 12/31/19 P3,671,490.00
Jan. 1 to May 31 (P3,667,594 x 10% x 5/12) P152,816.00

June 1 to Nov. 1 (P3,690,974 x 10% x 5/12)
b
153,791.00
2.) Total interest income for 2020 P306,620.00
Carrying value, 12/1/2019 P3,667,594.00

Add: Discount amortization, 12/1/19 to 5/31/20
Carrying value, 6/1/20 P3,690,974.00
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Total proceeds P3,925,000.00
Less: Accrued interest (P4,000,000 x 8% x 5/12) (133,333.00)
Sales proceeds 3,791,667.00
Less: Carrying value, 11/1/06 (see below) ( 3,711,432.00)
3.) Gain on sale on investment in bonds P 80,235.00
Carrying value, 6/1/20 P3,690,974.00
Add: Discount amortization, 6/1/20 to 11/1/20
4.) Carrying value, 11/1/20 P3,711,432.00
PRACTICAL PROBLEM NO. 3 – MILLAN Inc. .
Your audit of the MILLAN Inc., revealed the following transactions on its “Financial Asset at Fair Market Value through
profit or loss” account:
01/15/19 Purchased 40,000 shares of ABS at P21.50 per share and P1, 120, 000.00
20,000 shares of CBN at P13.00 per share. Amount
includes transaction costs amounting to P1.50 per share.
06/30/19 Purchased 1,000 of GMA Inc.’s 12%, 4-year, P1,000 face 1, 044, 258.00
value bonds dated January 1, 2017 and pays annual
interest every December 31. Prevailing interest on the
same date at 14%. Amount includes accrued interest and
transaction costs amounting to P10 per bond.
07/01/19 Received 3,000 shares of CBN as stock dividends, 36, 000.00

prevailing market price at P12 per share
08/05/19 Sold 15, 000 of ABS shares at P15 per share and 5,000 of P290, 000.00
CBN at 13 per share
12/01/19 Sold half of the GMA bonds at 98 plus accrued interest. 515,000.00
12/30/19 Received P80,000 in lieu of 5, 000 stock dividends from its 80,000.00
ABS shares
12/31/19 BALANCE P1, 315, 258.00
On December 31, 2019, the market values of the ABS and CBN shares were at P18 and P15 per share, respectively.
Moreover, the GMA bonds had a prevailing interest on the same date at 11%.
Questions:
1. How much is the total realized gain/loss on disposal of bonds on December 1?
2. How much should be the unrealized holding gain to be recorded in the income statement for the year 2019?
3. How much investment in trading securities should be reported in the statement of financial position?
Proceeds from sale plus accrued interest P545,000.00

(500,000*98%) + (500,000*12%*11/12)
Less: Carrying value
Total cash consideration paid P1,044,258.00
Less: Accrued interest (1M*12*6/12) (60,000.00)
Transaction cost (10,000.00) 974,258.00
Pro-rata: Portion sold 50% (487,129.00)
Accrued interest(P500,000*12%*11/12) (55,000.00)
1.) Realized gain on sale P2,871.00
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FMV 12/31/19 CV
ABS (25,000sh*P18) P450,000.00 P416,667.00 (a)
CBN (18,000sh*P15) 270,000.00 180,000.00 (c)
GMA at 11% yield rate
Principal (P500,000*0.9009009)
P450,450.00
Add: Interest (P60,000*0.9009009)
54,054.00 504,505,00 487,129.00
Total P1,224,505.00 1,083,796.00
2.) Unrealized holding gain- P&L P140,709.00
***
Initial cost ABS (40,000*20) P800,000.00

CV of 15,000 shares sold (300,000.00)
Effect of cash div. in lieu of stock div. (83,333.00) (b)
(5,000shares x P16.67**)
CV of ABS, 12/31/19 P416,667.00 (a)
*
CV of ABS before cash div. in lieu of stock div. P500,000.00
Divide by: #no. of shares (25,000+5,000) 30,000shares
CV of ABS after cash div. in lieu of stock div. P16.67**
Multiply by: Remaining shares 25,000shares
CV, 12/31/19 P416, 667.00
*
(c) Initial cost CBN (20,000*11.50) P230,000.00
CV of shares sold on 8/5 (50,000.00)
CV CBN 12/31/19 P180,000.00 (c)
FMV 12/31/19
ABS (25,000sh*P18) P450,000.00
CBN (18,000sh*P15) 270,000.00
GMA at 11% yield rate
Principal (P500,000*0.9009009) 450,450.00
Interest (P60,000*0.9009009)
54,054.00 504,505.00
3.) Total P1,224,505.00
PRACTICAL PROBLEM NO. 4 – Corgi Corporation .
Corgi Corp. Has the following non-trading securities on December 31, 2019:
Security # of shares Cost Fair Value (12/31/2018)

ABC 9,000 P 441,000.00 P 46.00 per share
DEF 30,000 1,080,000.00 35.00 per share
GHI 2,400 360,000.00 154.00 per share
Audit notes:
a. The above securities were all bought in 2018. on the initial recognition, Corgi made an irrevocable election
to present gain/loss on the said securities to other comprehensive income.
b. On April 1, 2019, the company sold all of the ABC ordinary shares for P65 per share.
c. On May 1, 2019, the company purchased 4,200 ordinary shares of JKL Corp. At P75 per share. The
company incurred brokers’ fees amounting to P10,400.
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d. The following additional information in 2019 were deemed relevant:
Dividends Declared Reported Net Income Fair value of shares

ABC ordinary shares P2/share P 900,000.00 P 62.00
DEF ordinary shares P1.5/share 1,300,000.00 38.00
GHI preference shares P1/share 750,000.00 145.00
JKL ordinary shares P0.75/share 450,000.00 77.00
Questions:
1. What is the realized gain on sale of ABC ordinary shares in 2019?
2. What is the unrealized holding gain/loss to be reported in the stockholder’s equity portion of the 2019 statement
of financial position?
Proceeds from sale (9,000*65 P585,000.00
Less: Original cost 441,000.00
1.) Realized gain on sale 144,000.00
FMV (12/19) Cost

DEf Corp. shares P1,140,000.00 P1,080,000.00
GHI Corp. shares 348,000.00 360,000.00
JKL shares 323,400.00 325,400.00
Total P1,811,400.00 P1,734,600.00
2.) Unrealized holding gain SHE P76,800.00
PRACTICAL PROBLEM NO. 5 – BARBIE Corporation .
BARBIE Corporation acquired a building on January 1, 2017.The acquisition cost is P5,000,000 payable at the rate of
P1M at the beginning of each year starting on January 1, 2017. The company paid option money totaling P400,000,
P85,221 of which is attributed to real properties not acquired. The company also paid property taxes in arrears.
The company also paid property taxes in arrears as of January 1, 2017 at P147,872. The prevailing market rate of
interest for transaction is 12%. The building is estimated to have useful life of 25 years.
The property was appraised at the end of each year as follows:
Year 2017 2018 2019

Appraised values P4,600,000.00 P4,100,000.00 P4,300,000.00
Questions:
1. What is the carrying value of the property as of December 31, 2019, assuming that the building is an investment
property under the cost method?
2. How much recovery gain should be recognized from the asset in the 2019 profit or loss?
Recoverable Amount 12/31/18 P4,100,000.00

Less: Depreciation 2019: 4.1M/23 years (178,261.00)
Carrying Value, before impairment recovery 3,921,739.00
1.) Carrying Value had there been no impairment (4.5M*22/25) P3,960,000.00
2.) Impairment recovery- P&L P38,261.00
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OUTLINE
1. Introduction
1.1 Quick review: Purpose of Property, Plant and Equipment
1.2 Nature of Property Plant and Equipment
1.3 Features of PPE That Have Impact on the Audit
1.4 Audit Objectives
1.5 Contrasts with Audit of Current Assets
1.6 Audit Documentation
1.7 Risk Assessment Procedures
1.8 Fraud Risks and Errors
1.9 Tests of Controls

2.1 Management Assertion: Existence / Occurrence
2.2 Management Assertion: Completeness
2.3 Management Assertion: Rights and Obligation
2.4 Management Assertion: Valuation and Allocation
2.5 Reconciliation of subsidiary ledger with general ledger
2.6 Examination of additions and disposals (including retirement):
2.7 Physical inspections of major additions of Plant and Equipment
2.8 Examine legal ownership of property and equipment
2.9 Analyze lease, repairs and maintenance expense accounts
2.10 Test the provision for Depreciation or Depletion
2.11 Examine impairments of Property, Plant and Equipment

3.1 Evaluate Financial Statement Presentation and Disclosures for Plant Assets and for Related Revenue and
Expenses
4.1 ABC Ltd.
4.2 Company A
4.3 Distress Company
4.4 Royal SPA
4.5 Window Company
5.1 Bobby Corporation
5.2 Meisner Corporation
5.3 GENLUNA COPPER MINES INC.
5.4 Delilah Mfg Co.
5.5 Grand Constructions
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AUDIT OF PROPERTY, PLANT, AND EQUIPMENT
Quick review: Purpose of Property, Plant and Equipment
PPE Purpose
 Property, Plant and Equipment To understand the nature and characteristics of PPE.
 Land and Building To know the proper statement classification of PPE.
 Machinery To identify the costs normally charged to the account of
PPE and related accounts.
 Depreciation & Depletion To identify the audit objectives for PPE and related
accounts.
 Revaluation To apply audit procedure to establish management

assertions on non-current operating assets and related
income and expenses.
 Borrowing Cost To explain the primary substantive audit procedure for

PPE and related accounts.
 Long Term Construction Contracts To identify internal control procedure relating to non-
current operating assets.
Introduction
Nature of Property Plant and Equipment
The term “property, plant and equipment” in respect of those entities which are required to comply with the
IAS 16 refers to such tangible items that:
 are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
 are expected to be used during more than one period.
Features of PPE That Have Impact on the Audit
 By their very nature, PPE are turned over much slower than current assets which are held for sale.
Normally, PPE are carried over from year to year.
 The average unit of PPE is normally of a relatively larger peso value.
 Since PPE are high value items, their acquisition is normally more closely controlled. The control
aspect assumes special significance where PPE are self-constructed.
 PPE are generally accounted for once unlike other assets like stock, because of which any error would
affect the financial statements permanently or at least for a significant period of time.
 In an inflationary situation, where cost model is adopted, normally, the book values of PPE are
considerably lower than their replacement values.
Audit Objectives
1. To use the understanding of the client and its environment to consider inherent risk, including fraud risk related
to PPE.
2. To obtain an understanding of internal control over the PPE.
3. To assess the risks of material misstatements and design tests of controls and substantive procedures that:
 Substantiate the existence of PPE and the occurrence of the related transactions
 Establish the completeness of recorded PPE
 Verify the cut-off of transactions affecting PPE
 Determine that the client has rights to the recorded PPE
 Establish the proper valuation or allocation of PPE and the accuracy of transactions affecting PPE
 Determine that the presentation and disclosure of information about PPE are appropriate, including
disclosure of depreciation methods
Contrasts with Audit of Current Assets
 A typical unit of PPE has a high peso value and relatively few transactions may lie behind a large
balance sheet amount
 There is usually little change in the property account from year to year.
 There is a lesser significance of year-end cut off transactions on net income.
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Internal Control Over Plant Assets
 The use of annual budget to be used to forecast and control acquisitions and retirements of plant
assets.
 A subsidiary ledger consisting of a separate record for each unit of property.
 A system of authorizations requiring advance executive approval of all plant and equipment
acquisitions, whether by purchase, lease, or construction.
 A reporting procedure assuring prompt disclosure and analysis of variances between authorized
expenditures and actual cost.
 An authoritative written statement of company policy distinguishing between capital expenditures and
revenue expenditures.
 Periodic physical inventories designed to verify the existence, location, and condition of all property
listed in the accounts and to disclose the existence of any unrecorded units.
 A system of retirement procedure, including serially numbered retirement work orders, stating the
reasons for retirement and bearing appropriate approvals.
Audit Documentation
1. A summary analysis emphasizing the changes in the company’s property, plant, and equipment during the
year under audit.
 Shows the beginning balances of various types of capital assets (ending amount of the prior year
working paper).
 Shows the additions and retirement during the year
 Shows the ending balances of the various accounts under PPE.
 Shows another four columns for the changes in the accounts for accumulated depreciation
2. Analyses of the year’s additions and retirements
3. Analyses of repairs and maintenance expense accounts
4. Tests of Depreciation
5. Documentation of the internal control and risk assessments for PPE
Risk Assessment Procedures

Inherent Risks
The auditor needs to obtain an understanding of the client and its environment to consider inherent risk,
including fraud risks, related to property, plant, and equipment. This includes:
1. Obtaining an understanding of the internal control over property, plant, and equipment. For example,
preparation of and review of capital budgets, etc.
2. Assessing the risks of material misstatement and designing tests of controls and substantive
procedures that cover the following aspects:
 Substantiate the existence of property, plant, and equipment. PPE may include assets that should
have been derecognized following sale, other transfer of rights or abandonment. Auditor should verify
title deeds, agreements or other ownership documents.
 Establish the completeness of recorded property, plant, and equipment. Expenditure that should
have been recognized as property, plant and equipment but has not been so recognized, including
capitalized finance costs, failure to account for assets held under finance leases or hire purchase
agreements.
 Verify the cutoff of transactions affecting property, plant, and equipment.
 Determine that the client has the rights to the recorded property, plant, and equipment.
 Establish the proper valuation or allocation of property, plant, and equipment and the accuracy of
transactions affecting PPE.
 Determine the correctness and appropriateness of classification of property, plant and equipment.
For example, incorrect split between land and buildings or between long term and short-term
leaseholds. Classification may have a significant impact on the application of the accounting policies.
As per relevant Accounting Standard, the entities have to follow the component approach, as may
be applicable.
 Depreciation value - Depreciation may have been incorrectly calculated on account of factors such
as:
 Carrying cost - Where a valuation model is followed - carrying amount may not reflect fair value due
to factors including:
- failure to update valuations for current circumstances; or
- failure to brief values correctly, use of invalid assumptions or data, etc., or
- valuations not performed by competent personnel.
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 Existence/valuation - tangible assets acquired in a business combination may not have been initially
recognized at their fair value at that date.
 Value of impairment - failure to recognize impairment or reversal of impairment.
 Determine that the presentation and disclosure of property, plant, and equipment are appropriate.
Fraud Risks and Errors
Some of the potential misstatements in PPE on account of frauds and errors include:
 Purchase of an asset at an inflated price especially from a related party.
 Wrong write-off of the asset as scrap, obsolescence, missing, donated, or destroyed.
 Expenditures for repairs and maintenance recorded as PPE or vice versa.
 Capitalization of expenditure which are not normally attributable to the cost of the PPE.
 Recording of an asset purchased, which in effect has not actually been received by the entity at all.
 Removal of an asset paid for by the entity or use of an asset of the entity for the benefit of a person
other than the entity.
Such errors and frauds could occur because of weak internal controls in the entity including:
 Inadequate involvement of management in overseeing employees with access to cash or other
assets susceptible to misappropriation.
 PPE which are small, marketable, or lacking observable identification of ownership.
 Lack of complete and timely verification and reconciliations of assets.
 Inadequate physical safeguards over PPE.
 The misuse of the entity’s assets by an employee.
 Using an entity’s assets for personal use (for example, using the entity’s assets as collateral for a
personal loan or a loan to a related party).
 The asset is intentionally sold below fair market value.
The auditor should perform risk assessment procedures to provide a basis for the identification and assessment of risks
of material misstatements. These would include:
 Inquiries of management and others within the entity to identify the risks. For example, control
procedures, entity’s objectives and strategies, incentive policies, etc.
 Analytical procedures, for example, Ratios, etc.
 Observation and inspection of the entity’s premises and plant facilities.
Test of Controls
 Check authorization of purchase of PPE to the BOD minutes of meetings, capital expenditure budgets
and capital expenditure forms.
 Check authorization for disposals of significant PPE.
 Confirm existence of PPE register or records which adequately identifies assets and comments on
their current condition. Ensure register reconciles to ledgers.
 Test of reconciliation of register to physical checks of existence and condition of assets.

 Management Assertion: Existence / Occurrence
Audit Objectives:
 To determine that property plant and equipment represent all tangible assets owned or held under
finance lease thar are used in the operation of the business. To determine further that additions,
include only the capitalizable costs of assets purchased, constructed, leased and retirement, sales,
trade-ins and other disposition during the period have been properly removed.
Audit Procedures:
 Trace opening balance at last year’s working papers.
 Vouch documents evidencing ownership.
 Obtain permission from the client to refer to the working papers of the predecessor.
 Consider conducting physical inspection of major properties.
 Management Assertion: Completeness
Audit Objectives:
 To determine that all capitalizable costs are included as property and are not expensed.
Audit Procedures:
 Examine or analyze repairs and maintenance account for possible asset acquisition charged as
expense.
 Search for unrecorded retirements by examination of cash receipts, tax declarations, insurance
records, credit to scrap sales, and inquiry of knowledgeable company personnel. And by a tour of the
company plant to observe indications of equipment removals.
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 Management Assertion: Rights and Obligation
Audit Objectives:
 To determine that the entity has legal title or equivalent ownership rights to property and equipment
included in the statement of financial position and the related lease obligation of finance leased assets
is recognized.
Audit Procedures:
 Examine lease agreement on property and equipment leased to and from other properties.
 Review rental revenue from land, buildings, and equipment owned by client but leased to others.
 Management Assertion: Valuation/ Allocation
Audit Objectives:
 To determine that property and equipment is stated at costs and allowances for depreciation and
depletion are computed on the basis of acceptable, consistent and reasonable methods.
 To determine that any impairment on the property and equipment are considered in the determination
of their carrying values as of the balance sheet date.
Audit Procedures:
 Examine and analyze repairs and maintenance account for possible asset acquisition charged as
expensed.
 Test client’s computation of depreciation.
1. Reconciliation of subsidiary ledger with general ledger
Reconciliation is an accounting process to compare two sets of records & ensure the figures are in agreement
and are accurate. Reconciliation is an important process to determine the money trail. The statement of fixed assets
reconciliation shows summary of book value, credits and debits to fixed assets accounts and accumulated depreciation
which is vital in reconciling balance sheet and the register of fixed asset.
The fixed asset reconciliation statement generally deals with the following on broader horizon:
 Whether the depreciation has been properly charged or not.
 Whether the addition of new assets to the accounts is justifiable or not.
 Whether the disposal of assets has been correctly booked or not.
 Whether the fixed assets show the proper value as on the closing date or not after taking various
adjustments
 Description of the asset or asset classification
 Cost of each asset or asset classification, including the opening balance at the beginning of the year,
additions and disposals, retirements and balance at year end.Accumulated depreciation showing the
beginning balance, debits to accumulated depreciation due to transfers, derecognition and reversals,
depreciation or depletion rate for each asset classification and balance at year end.
Example of a PPE schedule:
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Example of a Working Paper:
Example of a Fixed Asset Register:
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2. Examination of additions and disposals (including retirement):
After reconciling the general ledger and sub-ledgers of the PPE, the auditor vouches additions and disposals.
Vouching of additions to the property, plant and equipment accounts during the period under audit is considered one
of the most important substantive tests. The extent of vouching is dependent upon auditor’s assessment of control risk
for the existence and valuation of plant and equipment.
ADDITIONS
Normally, additions to property, plant and equipment are acquired and therefore, recorded at purchase
or acquisition cost. The auditor should examine on a test basis documentation supporting plant asset additions
and disposals. When testing additions, the auditor normally vouches all additions but, in some cases, the auditor
may decide to vouch only sample additions
The steps typically performed by the auditor to verify additions will include the following:
 For acquisition of property (e.g., land and building), the auditor should verify the occurrence and cost
of additions by examining the capital expenditure authorization and purchase agreement, contract
deeds, or other documentations. The auditor should also ensure that all costs of acquisition are
included in the PPE account
 For cost incurred related PPE (e.g., land improvements, building improvements, major repairs), the
auditor should examine supporting invoices and check whether the acquisition represent capital
expenditure based on the capitalization policy of the entity.
 For other additions to PPE, verify the occurrence and valuation by tracing the description and amount
to purchase orders, capital expenditure authorizations, contracts, suppliers’ invoices, or other
appropriate documentation.
DISPOSALS/ RETIREMENT
The principal purpose of this procedure is to determine whether any PPE has been replaced, sold,
or abandoned without such being reflected in the accounting records. The auditor typically includes the
following procedure to discover unrecorded retirements or disposals:
 Inquire of executives and supervisors of PPE retirements or disposals during the year;
 For new additions, determine status of old asset whether this represent a replacement of old asset;
 Analyze miscellaneous revenue contract for cash proceeds from sale of PPE;
 If a company’s product lines are discontinued, investigate disposition of plant facilities; and
 Examine retirement work orders or other source documents for proper authorization.
Property, Plant and Equipment under construction:

 The auditor should verify that PPE under construction are recognized as capital work in progress
until such time they are ready for intended use. The auditor should also verify that only those costs
that could be capitalized are included under work in progress.
 The auditor must verify records to ensure that the assets under construction or pending installation
and not yet ready for intended use are classified as work in progress
 Capital work in progress should be verified with reference to the underlying contractor progress
billings, work orders, labor charges and other supporting documents.
 The auditor should reconcile the movement of capital work in progress from opening to closing.
 The auditor should also specifically verify the date on which the assets are moved from the capital
work in progress account to the fixed assets.
3. Physical inspections of major additions of Plant and Equipment

A physical inspection of major units of plant and equipment acquired during the year under the audit is usually
performed by the auditor to determine that these assets do, in fact exist. This step is also helpful in maintaining a good
working knowledge of client operations, and in interpreting the validity of accounting entries for both additions and
retirements. Physical inspection is particularly appropriate if there appears to be weaknesses in the client’s internal
control over PPE.
The auditor’s direction in examining a PPE may flow in either of the following:
 Inspect the item of plant and equipment and trace it to the property, plant and equipment ledger. This
type of procedure provides evidence of completeness of recorded asset.
 Select items of plant and equipment from the ledger to the physical assets. This type of procedure
provides evidence of existence and condition of assets.
4. Examine legal ownership of property and equipment
Aside from physical inspection to verify the existence and condition of the equipment, the auditor examines proof
of legal ownership. To verify legal ownership of the assets, the auditor must examine evidence such us deeds of
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property, transfer of certificate of title (TCT), property tax bills and insurance policy. The ownership of machinery and
equipment can be verified by examining the purchase invoices and contract of sale.
5. Analyze lease, repairs and maintenance expense accounts

The auditor’s principal objective in analyzing the lease (rent), repairs and maintenance expense accounts is to
ensure that all capital expenditure should not been included in these expense accounts. Normally, the items of lease
expense and repairs and maintenance examined by the auditor are those items that involve significant amount.
 Lease expense
The auditor will normally examine the term of the lease contract to determine if the lease is
appropriately classified as operating lease. In operating lease, it expenses the lease payment
immediately while in finance lease it delays the recognition of expense, it should be accounted as
asset and depreciated.
 Repairs and Maintenance Expense
Repairs and Maintenance Expense are cost incurred to ensure that an asset continues to
operate. To determine that there is proper repairs and maintenance charges the auditor should obtain
the companies written policy regarding the capitalization of expenditures incurred in relation to a
property, plant and equipment as basis in determining the appropriateness of the classification of the
accounts. Extraordinary or extensive repairs and maintenance expense that will increase the value
or substantially prolong the useful life of the property should be capitalized.
6. Test the provision for Depreciation or Depletion

Depreciation or Depletion is an example of accounting estimate. PSA 540 requires that in evaluating accounting
estimates, auditors first obtain an understanding of the client’s process and controls in developing accounting estimates.
In auditing depreciation or depletion, the auditor’s objective is to obtain sufficient appropriate evidence about whether:
 Depreciation or depletion recognized in the financial statements are reasonable; and
 Related disclosures required in the financial statements are adequate.
Audit procedures to test the reasonableness of depreciation and depletion:
1. Review the depreciation policies set forth in company manuals and determine if it is applied
consistently;
2. Obtain or prepare a summary analysis of accumulated depreciation for the major property
classification as shown by general ledger accounts, listing beginning balances, provisions for
depreciation during the year, retirements, and ending balances.
 Compare beginning balances with the audited amounts in last year/s working papers.
 Determine that the totals accumulated depreciation recorded in the plant and equipment
subsidiary records agree with the applicable general ledger controlling accounts.
3. Test the provisions for depreciations
 Compare rates used in prior years and investigate any variance.
 Check the computation of depreciation by performing independent recalculation
 Compare credits to accumulated depreciation accounts the year’s depreciation provisions with
debits entries in related depreciation expenses accounts.
4. Test deductions from accumulated depreciation for assets retired.
 Trace deductions to the working paper analyzing retirements of assets during the year.
 Test the accuracy of accumulated depreciation to date of retirements.
5. Perform analytical procedures for depreciation
 Compute the ratio of depreciation expenses to total cost of plant and compare with prior years.
 Compare the percentage relationships between accumulated depreciation and related property
accounts with that prevailing in prior years. Discuss significant variations from normal
depreciation program with appropriate members of managements.
In audit of companies operating properties subject to depletion (mines, oil and gas, deposits,
timberlands and other natural resources), the auditors follow a pattern similar to that used in evaluating
the provision for depreciation expense and accumulated depreciation. They determine whether depletion
has been recorded consistently and in accordance with generally accepted accounting principles and they
test the mathematical accuracy of client’s computation.
Lapsing Schedule
It is a worksheet containing specific accounting data about fixed assets such as the original purchase cost,
useful life, accumulated depreciation, additions, sales of assets, and so on. Presented below is an example of a
lapsing schedule which is essential in conducting an audit of PPE.
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Example of a Lapsing Schedule
7. Examine impairments of Property, Plant and Equipment

PAS 36 requires that an entity should review assets for impairment whenever events or changes in circumstances
indicate that carrying value may not be recoverable. In assessing the proprietary of impairment, the auditor should
inquire with management their approach in identifying indicators of impairment, and the actions taken as a result of any
potential impairment noted. If an impairment provision was made of the auditor considers it necessary, the auditor
ordinarily should perform the following procedures:
a. Evaluate the appropriateness of the valuation model and assumptions used;
b. Assess the reasonableness of management’s estimates; and
c. Evaluate the accuracy, completeness, and the relevance of the important data on which the estimates
or measurements are based.

Evaluate Financial Statement Presentation and Disclosures for Plant Assets and for Related Revenue and
Expenses
The auditor should check whether the entity has disclosed the following requirements under PAS 16:
o Basis for measuring carrying amount
o Depreciation method used
o Useful lives or depreciation rates used
o Gross carrying amount and accumulated depreciation and impairment losses at the beginning and
end of the period
o Reconciliation of the carrying amount at the beginning and the end of the period
o Restrictions on title
o Expenditures to construct PPE during the period
o Commitments to acquire PPE
o Compensation from third parties for items of PPE that were impaired, lost or given up that is included
in profit or loss.
SITUATIONAL PROBLEM NO.1- ABC Ltd.

The manager had been given P300,000 and submitted purchase order to furnish the office (furniture, fixtures
and office equipment). However, the manager schemed with a vendor, a related party of the manager, to actually
spend less than P200,000 by substituting lesser quality items and then split the over P100,000 in extra payment
with the office furnishing vendor. How do auditors uncover this kind of transaction?
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In this case, the documents like purchase invoices are not reliable sources since the vendor is involved in
fraud made by the manager. The possible audit procedures that the auditor can conduct on his audit are the
following. The auditor must obtain documents and data sources like Minutes from board of director’s meeting
because before the company acquire fixed assets, the acquisition must first authorize by the board of directors on
their meeting. By asking their minutes from their meeting, auditor can obtain information about the authorize value,
quantity, quality and the approved supplier of the said asset. After obtaining some evidences, auditor can conduct
physical inspection on acquired assets. Physical examinations are useful procedures for auditing assertions
because it provides highly reliable audit evidence regarding the existence and sometimes the correct valuation of
assets. Inspections go beyond merely scrutinizing the supporting documents. It can verify that the items in the
documents do, in fact, exist as observed by the auditor. This physical examination gives greater assurance that
company records represent business assets accurately.
SITUATIONAL PROBLEM NO. 2- Company A

On March 10, 2019, the manager of A company sold its old equipment with a carrying amount of P80,000 to
C company for P100,000 and bought a new equipment but they did not remove the old asset in their balance sheet.
As a result, their assets appeared on their balance sheet are overstated. How do we trace the unrecorded
disposals?
Discussion on the case:
In searching for unrecorded disposals, the first thing that we have to do is to review whether newly acquired
assets replace existing assets. Since every time they buy an asset, it might replace an old one. And replacing an
old one means an old one is gone. So ask them what is the purpose of buying new assets. Another thing is we
have to analyze gains and losses on the disposal of assets and miscellaneous income for receipts from asset
disposals. By looking at gains and losses on the income statement, we can examine if it is the result of selling an
asset if there is any disposal made by the client. We also have to review plant modifications and changes in product
line, property taxes and insurance coverage because any changes on these might indicate deletions of equipment.
For example, once the company disposed the assets, they must remove it from their insurance simply because
they don’t want to pay insurance expense so we have to ask their company’s insurance policy for these concern.
And lastly we must always make inquiries of management and production personnel about disposal of assets.
SITUATIONAL PROBLEM NO. 3- Distress Company

Employees of Distress Company sold one of the old equipment of the company for P50,000 to Happy
Company and pocketed the proceeds. They recorded the transaction as Scrapped. What procedures we need to
do to address this wrong write-off of asset.
The auditor needs to examine whether the recorded retirements have been properly authorized and
appropriate procedures have been followed. The auditors can make inquiries on the executives and supervisors
of PPE to confirm if there is actually an authorized retirements or disposals this year. Auditors can also examine
retirement work orders or other source documents for proper authorization. They can also investigate any reduction
in insurance coverage as this may indicate retirement of PPE. If there is not any evidence of the recorded
retirement, then it might indicate a red flag or a fraud regarding the disposals of the asset.
SITUATIONAL PROBLEM NO.4- Royale SPA

Royale SPA is a business offering therapeutic treatment. Among their fixed assets were paintings, prints and
sculptures displayed in their business to relax their customers with a total value of almost 1Million. However,
Anderson, while doing his audit, found a number of paintings, prints and sculptures with a lesser value.Subsequent
investigation revealed that employees would take home artwork that they wanted. And replace the artwork with
something that they either had at home or purchased from the store. Management was focused in their business
and therefore had turned a blind eye to the substitutions. What audit procedures to address this kind of situation.
The auditor can ask the working paper of physical verifications from managements or records of asset that
contain descriptions of assets, classifications, values and quantities. It is the responsibility of the management to
carry out physical verification of fixed assets at appropriate intervals in order to ensure that they are in existence
and to record the descriptions of their assets. However, the auditor should satisfy himself that such verification was
done by observing the verification being conducted by the management wherever possible and by examining the
written instructions issued to the staff by the management and the relevant working papers.
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The auditor should also satisfy himself that the persons conducting the verification, whether the employees of
the enterprise or outside experts (if employed), had the necessary competence. After obtaining the working papers,
auditor should conduct Physical Inspections of assets to satisfy himself that the actual assets are in accordance
of what was recorded in the documents.
SITUATIONAL PROBLEM NO.5- Window Company

Management of Window Company made some misstatements in their PPE account on their balance sheet by
capitalizing the expenditures (repair and maintenance) which are not normally attributable to the cost of PPE that
results to an overstatement of their assets on their Balance sheet. What procedures to address this situation?
The auditor should analyze the lease, repair and maintenance expense accounts to ensure that all capital
expenditure should not been included in these expense accounts. For repairs and maintenance expense accounts,
the auditor should obtain the companies written policy regarding the capitalization of expenditures incurred in
relation to a property, plant and equipment as basis in determining the appropriateness of the classification of the
accounts. In addition, for lease expense, the auditor will normally examine the term of the lease contract to
determine if the lease is appropriately classified as operating lease, otherwise this should be accounted as an
asset and depreciated.
PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – Bobby Corporation

On January 2, 2017, Bobby Corporation purchased a tract of land (site number 501) with a building for P600,000.
Additionally, Bobby paid a real estate broker’s commission of P36,000, legal fees of P6,000, and the title guarantee
insurance of P18,000. The closing statement indicated that the land value was P500,000 and the building value was
P100,000. Shortly after acquisition, the building was razed at a cost of P75,000.
Bobby entered into a P3,000,000 fixed-price contract with Teddy Builders, Inc. on March 2, 2017 for the construction
of an office building on land site 501. The building was completed and occupied on September 30, 2018. Additional
construction costs were incurred as follows:
Plans, specifications, and blueprints P12,000.00
Architects’ fee for design and supervision 95,000.00
The company estimates that the building will have a 40-year useful life from date of completion and decides to use the
150% declining-balance depreciation method. To finance the construction cost, Bobby borrowed P3,000,000 on March
2, 2017. The loan is payable in 10 annual installments of P300,000 plus interest at the rate of 14%. Bobby’s average
amounts of accumulated building construction expenditures were as follows:
For the period March 2 to December 31, 2017 P 900,000.00
For the period January 1 to September 30, 2018 2,300,000.00
Questions:
1. Prepare a schedule that discloses the individual costs making up the balance in the Land account with respect to
land site 501 as of September 30, 2018.
2. Prepare a schedule that discloses the individual costs that the company capitalize in the Office Building Account
as of September 30, 2018.
3. Prepare a schedule showing the depreciation expense computation of the office building for the year ended
December 31, 2018.
1: Land account (Site Number 501)

Acquisition cost P600,000.00
Add: Real estate broker’s commissions 36,000.00
Legal Fees 6,000.00
Title guarantee insurance 18,000.00
TOTAL P660,000.00
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2: Capitalized Cost of Office Building
Contract cost P3,000,000.00
Add: Plans, specifications, and blueprints 12,000.00
Architects’ fee for design and supervision 95,000.00
Capitalized interest (March 2 to 105,000.00
December 31, 2017) *
Capitalized interest (January 1 to 241,500.00
September 30, 2018) **
Cost of razing of existing bldg. 75,000.00
TOTAL P3,528,500.00
* March 2 to December 31, 2017 (900,000 X 14% x 10/12) P105,000.00
** January 1 to September 30, 2018 (2,300,000 x 14% x 9/12) 241.500.00
3: Computation of Depreciation of Office Building
Capitalized Cost P3,528,500
Multiply by: 150% Declining Rate .0375
Annual Depreciation P 132,319
Depreciation charge (October 1 to P132,319 x 3/12

December 31): =P33,080
PRACTICAL PROBLEM NO. 2 – Meisner Corporation

You requested a depreciation schedule for Delivery Trucks of Meisner Corporation showing the additions, retirements,
depreciation and other data affecting income of the company in the 4-year period 2015-2018, inclusive. The Delivery
Trucks account consists of the following as of January 1, 2015:
Truck No. 1 purchased Jan. 1, 2012, cost P 180,000.00
Truck No. 2 purchased July 1, 2012, cost 220,000.00
Truck No. 3 purchased Jan. 1, 2014, cost 300,000.00
Truck No. 4 purchased July 2, 2014, cost 240,000.00
TOTAL P 940,000.00
The Delivery Trucks-Accumulated Depreciation account previously adjusted to January 1, 2015and duly entered to the
ledger, had a balance of P 302,000 (depreciation on the 4 trucks from respective date of purchase, based on five-year
life; no salvage value). No charges have been made against the account before January 1, 2015.
Transactions between January 1, 2015 and December 31, 2018, and their record in the ledger were as follows:
July 1, 2015 Truck No. 3 was traded for larger one (No. 5), the agreed purchase price of which was
P340,000. Meisner Mfg. Co. paid the automobile dealer P150,000 cash on the
transaction. The entry was debit to Delivery Trucks and a credit to cash, P150,000.
Jan. 1, 2016 Truck No. 1 was sold for P35,000 cash; the entry debited Cash and credited Delivery
Trucks account, P35,000.
July 1, 2017 A new truck (No. 6) was acquired for P360,000 cash and was charged at that amount to
Delivery Trucks account. (Assume Truck No. 2 was not retired)
July 1, 2017 Truck No. 4 was damaged in a wreck to such an extent that it was sold as junk for
P7,000 cash. Meisner Mfg. Co. received P25,000 cash from the insurance company.
The entry made by the bookkeeper was a debit to cash P32,000, and credits to
Miscellaneous Income, P7,000 and Delivery Trucks P25,000.
Entries of depreciation had been made for the close of each year as follows: 2015, P203,000; 2016, P211,000; 2017,
P244,500; 2018, 278,000.
Questions:
Based on the above and the result of your audit, determine the following:
1. The effect of any misstatement to the 2015 profit
4. The adjusted carrying amount of Delivery Trucks as of December 31, 2018
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Unrecorded Loss on Trade-In of Truck 3:
Trade in Value (P340,000-P150,000) P190,000.00
Less: Carrying Amount, 7/1/15 (300,000*3.5/5) (210,000.00) P20,000.00
Overstatement of Depreciation Expense:
Truck No. 1 (180,000/5) P36,000.00
Truck No. 2 (220,000/5) 44,000.00
Truck No. 3 (300,000/5*6/12) 30,000.00
Truck No. 4 (240,000/5) 48,000.00
Truck No. 5 (340,000/5*6/12) 34,000.00
Should Be Depreciation Expense P192,000.00
Depreciation Expense per books (203,000.00) (11,000.00)
1.) Overstatement/(Understatement) of 2015 Profit P9,000.00
Unrecorded Loss on Sale of Truck 1:

Sales Proceed P35,000.00
Carrying Amount, 1/1/16 (180,000*1/5) (36,000.00) P1,000.00
Truck No. 2 (220,000/5) P44,000.00
Truck No. 4 (240,000/5) 48,000.00
Truck No. 5 (340,000/5) 68,000.00
Depreciation Expense per Books (211,000.00) (51,000.00)
2.) Overstatement/(Understatement) of 2016 Profit (P50,000.00)
Unrecorded Loss on Disposal of Truck 4:

Sales Proceed P7,000.00
Add: Insurance Proceeds 25,000.00
Total P32,000.00
Less: Carrying Amount (96,000.00) P64,000.00
Erroneous Credit to Miscellaneous Income 7,000.00
Truck No. 2 (220,000/5*6/12) P22,000.00
Truck No. 4 (240,000/5*6/12) 24,000.00
Truck No. 5 (340,000/5) 68,000.00
Truck No. 6 (360,000/5*6/12) 36,000.00
Depreciation Expense Per Book (244,500.00) (94,500.00)
3.) Overstatement/(Understatement) of 2017 Profit P23,500.00
Cost Accumulated Carrying

Depreciation. Amount
12/31/18
Truck No. 1 (sold, 1/1/15) - - -
Truck No. 2 (acquired, 7/1/12) 220,000.00 220,000.00 -
Truck No. 3 (Traded-In, 7/1/16) - - -
Truck No. 4 (damaged and sold, 7/1/17) - - -
Truck No. 5 (acquired, 7/1/15) 340,000.00 238,000.00 102,000.00
Truck No. 6 (acquired, 7/1/17) 360,000.00 108,000.00 252,000.00
4.) Totals 920,000.00 566,000.00 354,000.00
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PRACTICAL PROBLEM NO. 3- GENLUNA COPPER MINES, INC
On June 30, 2017, the GENLUNA COPPER MINES, INC. purchased a copper mine for P14,580,000. The estimated
capacity of the mine was 1,620,000 tons. Genluna Copper Mines expects to extract 15,000 tons of ore a month with an
estimated selling price of P50 per ton. Production started immediately after some new machines costing P1,800,000
were bought on June 30, 2017. These new machines had an estimated useful life of 15 years with a scrap value of
10% of cost after the ore estimate has been extracted from the property, at which time the machines will already be
useless. Genluna’s books show the following expenses for 2017:
Depletion expense P1,215,000.00

Depreciation—Machinery 120,000.00
Questions:
1. The effect of any misstatement on recorded depletion expense was:
2. The effect of any misstatement on recorded depreciation expense was:
Depletion Expense Per Book P1,215,000.00
Less: Should Be Depletion Expense [(P14,580,000/1,620,000tons) *15,000tons*6mos.] 810,000.00
1.) Overstatement/(Understatement) of Depletion Expense P405,000.00
Depreciation Expense Per Book P120,000.00

Less: Should Be Depreciation Expense [(1,800,000*90%)/(1,620,000/(15,000*12))*6/12] (90,000.00)
2.) Overstatement/(Understatement) of Depreciation Expense P30,000.00
PRACTICAL PROBLEM NO. 4 – Delilah Mfg. Co.

On January 1, 2018, Delilah Mfg. Co. began construction of a building to be used as its office headquarters. The building
was completed on June 30, 2019.
Expenditures on the project were as follows:
January 3, 2018 P2,500,000.00
March 31, 2018 3,000,000.00
June 30, 2018 4,000,000.00
October 31, 2018 3,000,000.00
January 31, 2019 1,500,000.00
March 31, 2019 2,500,000.00
May 31, 2019 3,000,000.00
On January 3, 2018, the company obtained a P5-Million construction loan with a 10% interest rate. The loan was
outstanding all of 2018 and 2019. The company’s other interest-bearing debts included a long-term note of P25 million
with an 8% interest rate, and a mortgage of P15 million on another building with an interest rate of 6%. Both debts were
outstanding during all of 2018 and 2019. The company’s fiscal year-end is December 31.
Questions:
1. What is the amount of capitalizable interest in 2018?
2. What is the amount of capitalizable interest in 2019?
3. What amount of interest should be expensed in 2019?
4. What is the total cost of the building including interest capitalizd in 2018 and 2019?
For Requirement 1
Step 1: Capitalization Rate of General Borrowings
Principal Interest Rate Borrowing Cost
Long Term Note P25,000,000.00 8% P2,000,000.00
Mortgage Payable 15,000,000.00 6% 900,000.00
Total 40,000,000.00 2,900,000.00
Capitalization Rate (P2,900,000/P40,000,000) 7.25%
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Step 2: Average Carrying Amount
Date Cost Incurred Month Weighted Cost
Outstanding
January 3, 2018 P2,500,000.00 12 P30,000,000.00
March 31, 2018 3,000,000.00 9 27,000,000.00
June 30, 2018 4,000,000.00 6 24,000,000.00
October 31, 2018 3,000,000.00 2 6,000,000.00
Total P87,000,000.00
Weighted Average Carrying Amount (90M/12) P7,250,000.00
Step 3: Capitalizable General Borrowing Cost
Weighted Average Carrying Amount P7,250,000.00
Less: Specific Borrowing (5,000,000.00)
Excess of WACA over Specific Borrowing P2,250,000.00
Multiply by: Capitalization Rate 7.25%
Capitalizable General Borrowing Cost P163,125.00
Step 4: Total Capitalizable Borrowing Cost

Add: Actual Specific Borrowing Cost (5,000,000*10%) 500,000.00
1.) Capitalizable Borrowing Cost P663,125.00
For Requirement 2
Step 1: Average Carrying Amount
Date Cost Incurred Month Weighted Cost
Outstanding
January 1, 2019 P13,163,125.00 6 P78,978,750.00
January 31, 2019 1,500,000.00 5 7,500,000.00
March 31, 2019 2,500,000.00 3 7,500,000.00
May 31, 2019 3,000,000.00 1 3,000,000.00
Total P96,978,750.00
Weighted Average Carrying Amount (96,978,750/6) 16,163,125.00
Step 2: Capitalizable General Borrowing Cost
Weighted Average Carrying Amount P16,163,125.00
Less: Specific Borrowing (5,000,000.00)
Excess of WACA over Specific Borrowing P11,163,125.00
Multiply by: Capitalization Rate 7.25%
Multiply by: Term 1/2
Step 3: Total Capitalizable Borrowing Cost
Add: Actual Specific Borrowing Cost (5,000,000*10%*6/12) 250,000.00
2.) Capitalizable Borrowing Cost P654,663.28
For Requirement 3
Construction Loan P 5,000,000.00 10% P 500,000.00
Long Term Note 25,000,000.00 8% 2,000,000.00
Total 3,400,000.00
Total P3,400,000.00
Less: Capitalized Borrowing Cost (663,125.00)
3.) Charged to Interest Expense P2,736,875.00
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For Requirement 4
Construction Loan 5,000,000.00 10% P 500,000.00
Long Term Note 25,000,000.00 8% 2,000,000.00
Total P 3,400,000.00
Less: Capitalized Borrowing Cost (654,663.28)
Charged to Interest Expense P 2,745,336.72
PRACTICAL PROBLEM NO. 5 – Grand Constructions

Grand Constructions began operations in 2018. Construction activities for the first year is shown below. All contracts
are with different customers, and any work remaining at December 31, 2018 is expected to be completed in 2019.
Grand uses the cost-to-cost percentage of completion in accounting for its projects.
Additional
Billings To- Collections To- Actual Costs
Project Contract Price Cost to
Date date To-Date
Complete
One 560,000 360,000 340,000 450,000 130,000
Two 670,000 220,000 210,000 126,000 504,000
Three 520,000 500,000 440,000 330,000 0
Totals 1,750,000 1,080,000 990,000 906,000 634,000
Questions:
1. Calculate the aggregated net profit recognized in the 2018 income statement for these projects.
2. Calculate the amount of inventory recognized as a current asset in the 2018 balance sheet.
3. Calculate the amount of current liability recognized in the 2018 balance sheet.
4. Assume Grand uses the cost recovery method instead, calculate the aggregated net profit in the 2018 income
statement for these projects.
For Requirement 1
Project Contract Price Estimated Cost Contract Gross Percentage of Recognized
to Complete Profit Completion Profit
One P560,000.00 P580,000.00 (P20,000.00) 100% (P20,000.00)
Two 670,000.00 630,000.00 40,000.00 20% 8,000.00
Three 520,000.00 330,000.00 190,000.00 100% 190,000.00
Total P1,750,000.00 P1,540,000.00 P210,000.00 1.) P178,000.00
*Percentage of Completion of Project Two: 126,000/630,000=20%
For Requirements 2 and 3
Project Cost Incurred Gross Profit Construction in Progress Billings Asset/
Progress (Liability)
One P450,000.00 (P20,000.00) P430,000.00 P360,000.00 2.) P70,000.00
Two 126,000.00 8,000.00 134,000.00 220,000.00 3.) (P86,000.00)
Three Completed Contract
For Requirement 4
Project Contract Price Estimated Cost Contract Gross Percentage of Recognized
to Complete Profit Completion Profit
One P560,000.00 P580,000.00 (P20,000.00) 100% (P20,000.00)
Two 670,000.00 630,000.00 40,000.00 20% -
Three 520,000.00 330,000.00 190,000.00 100% 190,000.00
Total P1,750,000.00 P1,540,000.00 P210,000.00 4.)P170,000.00
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OUTLINE
1. Introduction
1.1 Categories and Examples of Intangible Assets
1.2 Inherent Risk Assessment
1.3 Control Risk Assessment

2.1 Substantive Testing of Intangible Assets
2.2 Assertions
2.3 Substantive Testing of Goodwill
2.4 Audit of Other Assets
2.4.1 Inherent Risk Assessment
2.4.2 Control Risk Assessment
2.4.3 Audit Objectives
2.4.4 Substantive Procedures
3.1 Star Records
3.2 Hidalgo Company
3.3 Mercadejas Company
3.4 Buenaventura Company
3.5 Elizalde Company
4.1 Tokyo Corporation
4.2 Lady Han Cookie Corporation
4.3 Bekenemen Corporation
4.4 Pink Corporation
4.5 Silver Corporation
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AUDIT OF INTANGIBLE ASSETS
Introduction
What is an intangible asset?
An intangible asset is an identifiable, non-monetary asset without physical substance controlled by the entity
from which future economic benefits are expected to flow to the entity.
An intangible asset is considered identifiable if it either is separable (meaning capable of separated or divided
from the entity and sold, transferred or rented out.) or arises from legal or contractual rights regardless if those rights
are separable from the entity.
Control means that means the entity has the right to use of asset and inflows resulting from the said use or from
restricting other parties from using the asset.
Future economic benefits arise from the control f intangible asset. This benefit may be in the form of revenue
increase or cost reduction.
Take in mind that intangible asset or at least identifiable intangible assets are non-monetary, identifiable, and
without physical substance. Identifiable which what differentiates it from goodwill, non-monetary which differs it from
investments and cash, and without physical substance in contrast to PPE and inventories.
Categories and examples of intangible assets:
 Artistic: things protected by a copyright. Original works are copyrighted from moment of creation.
 Customer: Customer lists, order backlogs, customer relations.
 Marketing: Trademark, brand name, domain name.
 Technology: Both those patented and unpatented.
 Contract: Licenses, franchises, and broadcasting rights.
Inherent risks assessment:
 Can cause serious risks considerations. It is since they are intangibles and that they will appear on the
balance sheet. They have value but lacks physical substance and it’s going to be difficult to verify/test prove
the value of these things.
 Risks can be great because accounting rules are complex, and the transactions are difficult to audit.
 Accounting standards require different asset impairment tests for different classes of intangible assets.
Assets should not be recorded more than is recoverable amount. Since theses intangible assets have
different nature and entities have different cases the test of impairment of this asset will be different.
Because of that it will be riskier for us to determine whether an intangible asset is impaired or not.
 Auditors often assess the inherent risk as high given the factors above.
Control risks assessment:
 Expertise and experience of those calculating the fair value of the asset.
 Control over the process used to determine fair value measurements, like controls over data and
segregation of duties between people committing the entity to the purchase and people assigning the
valuation
 How much the business relies on and employs valuation specialist?
 Are there significant management assumptions in determining fair value?
 The integrity of change controls and security procedures for valuation models and information systems.
Controls over approval process.
Substantive Testing of Intangible Assets:

Test related to valuation and impairment of intangible assets is often necessary because the complexity and
degree of judgement increase the risk of material misstatements.
Substantive evidence is required for all significant accounts and substantive analytical procedures alone are
not generally enough to provide sufficient evidence for significant transactions involving intangible assets.
Assertions:
 Existence – We want to make sure that they exist. Since there is no physical substance, we cannot just go
look at them like we would on inventories or PPE.
 Valuation – All intangible assets including impairment if there is any shall be recorded on their appropriate
value.
 Completeness – All intangible asset owned by the company is included in the statement of financial position.
 Rights and Obligation – Are there any legal rights in relation to the assets?
 Classification – All intangible assets and their related accounts are properly classified and disclosed on the
financial statements with their notes in accordance with PFRS.
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The following are the substantive procedures for intangibles:
1. Review of appropriate documentations- Determine that the intangible asset exist by reviewing appropriate
documentation, for example, legal documentation (in case of patent or license). Determine that the
intangible assets are owned by the entity by inspecting relevant documentation, such as purchase
agreement or sale agreement.
2. Recalculations of any gain or loss on disposal - Determine whether the carrying amount have been properly
reduced.
3. Recalculation of amortization expense- For amortizable assets with finite lives determine whether
amortization expense is accurate, and the amortization policy and useful lives are reasonable and consistent
with prior years.
4. Inquiry regarding intangibles with unrecoverable amount- When there is unrecoverable amount, evaluate
management’s impairment testing and conclusion regarding the write-off.
Substantive testing of goodwill:
Goodwill is considered unidentifiable because it has failed to comply with the criteria mentioned earlier. Keep
in mind that we ae talking about good will resulting from business combination and not an internally generated one.
Goodwill is also normally included only in reconciliated financial statements.
The following are the substantive procedures for goodwill:
1. Confirmation of document prepared to acquire business
2. Recalculation of cost of goodwill
3. Review of impairment
Audit of Other Assets:
 Prepaid Expenses – refer to the deferrals that will become expenses within one year. The amount that has
not been expensed as of the balance sheet date will be reported as a current asset.
 Deferred Charges (also known as Deferred expenses) -are long-term prepaid expense and will be reported in
the long-term asset section of the balance sheet under the classification of other assets.
Note: Both refer to a payment that was made, but due to the matching principle, the amount will not become
an expense until one or more future accounting periods.
Inherent Risk Assessment:
The inherent risk associated with these assets is generally assessed as low because the accounts do not
involve any complex or contentious accounting issues.
Control Risk Assessment:
These accounts are related to acquisition and payment cycle, and these should be ensured that each item are
properly authorized and recorded.
Audit Objectives:
 All amounts reported as assets were acquired in authorized transactions and were properly recorded at the
time of acquisition.
 The prepaid expenses and deferred charges are included on the statement of financial position at appropriate
amount and are being allocated in a systematic and rational manner to the accounting periods estimated to
be benefited.
 The other assets are properly classified, described, and disclosed in the financial statement, including notes
in accordance with PFRS.
Substantive Procedures:
Verify Existence and Valuation of Prepaid Expenses and Deferred Charges, and are normally processed
under:
1. Verify the existence of prepayments by examining invoices, contracts and other supporting documents
2. Ascertain whether the amount reported as asset will benefit the succeeding period and bears a
reasonable relationship to the unexpired benefit.
3. Audit the corresponding prepayment that was recognized as period expense during the current period.
SITUATIONAL PROBLEM NO. 1 – Star Records .

Star Records is a Record Label in the Philippines and has been a client of Riego’s Auditing Firm for years. On
December 28, 2019, during the course of audit, it was discovered that one of the Star Record’s artists, James Blue
and his hugely successful song, Neteterente Ne was subject of a huge lawsuit when the family of the late Daniel
Padila accused the artist of copyright infringement. They claimed that the catchy walking bass used for the pop hit
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was taken from Padila’s 1977 funk song Eke’y nehehele ne. In the end, the jury sided with Daniel Padila. Star
Records and Blue were ordered to pay the family 50% of all the royalties for the song. They were also given 2
years to stop the publishing and distributing of the song.
The auditor should perform the following procedures:
1. Adjust the useful life of the copyright from 30 years (based on market trend) to 2 years. Useful life is that
period in which benefits, sales, and royalties are expected.
2. Test for impairment since there is an indication that carrying value may not be recoverable.
SITUATIONAL PROBLEM NO. 2 – Hidalgo Company .

Hidalgo Company has been involved in a project development of engines that run on extracts from sugarcane.
The entity commenced the project in 2016 and has been a client of Riego’s Auditing Firm since then. For 4 years
of continuous research and development, Hidalgo Company has already spent 140 million pesos for research and
another 980 million for development of the 120 engines that are now being used for commercial production. On
December 30, 2020, the auditor noticed the amount increased in the Company’s assets, it was 30% higher than
the usual. It also came to his knowledge that the entity hired a new employee which is responsible for classifying
whether the criteria for research and development have been met.
1. When dealing with research and development, it is important that the criteria for recognition of intangible
assets were strictly being met.
2. The auditor may review the assets increases and may sample test to verify that capitalization
requirements are satisfied.
SITUATIONAL PROBLEM NO. 3 – Mercadejas Corporation .

Mercadejas Corporation is a well-established company known for its trademark, Bato-Stone Cement. It is also
recognized for successfully defending its numerous developed patents. The entity’s prestigious image in the
business world has been going on for 20 years until that fateful accident happened on October 20, 2019. Authorities
claim that inadequate safety measures and malfunctioning equipment at Mercadejas Corporation caused industrial
materials to heat up to 1,200 degree Celsius, spilling on site, and killing 30 workers alongside injuring 44 others. It
was named as the biggest tragedy in the cement industry.
Auditors in the Riego’s Auditing Firm have been anticipating a decline in their assets due to the accident. But
during the course of Audit, they discovered that the figures didn’t shred a single number but rather, increased.
1. Verify the existence and valuation of Intangible Assets.
2. Verify the completeness and accuracy of amortization figures.
SITUATIONAL PROBLEM NO. 4 – Buenaventura Company .

Buenaventura Company is a multi-national Company which decided to venture in Aviation Industry. They have
been on it for 9 years until the board decided that they will no longer renew their airline right next year. They
stopped complying with the applicable rules and regulation surrounding renewal. And as of December 30, 2019,
the airline right is still not amortized and the company’s accountants still expect it to provide service indefinitely
because they are not briefed about the decision of the board. What audit procedures are needed to address this
kind of situation?
1. Check the minutes from the meeting of the Board.
2. Airline right should be amortized over the remaining useful life (1 year) and immediately tested for
impairment.
SITUATIONAL PROBLEM NO. 5 – Elizalde Company .

Elizalde Company purchased a franchise from Jollicat Company to sell Jollicat products for 20 years. 15 years
after, the company decided to sell its franchise rights acquired from Jollicat and purchase a new franchise from
MeowcDo instead. The accountants were told to not remove the sold franchise right in their balance sheet and this
results to overstated assets. How do auditors discover unrecorded disposal of intangible assets?
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1. Check and review other income and look for receipts from asset disposal.
2. Analyze the records which shows the payment of the periodic fees.
PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – TOKYO CORPORATION .

The following amounts are included in the general ledger of TOKYO CORPORATION at December 31, 2019:
Question:
1. On the basis of the above information above, what is the total amount of intangibles assets to be reported by TOKYO
CORPORATION in its statement of financial position at December 31, 2019?
Suggested Solution:
Trademarks P45,000.00
Patents 225,000.00
1.) Total intangible assets P270,00.00
PRACTICAL PROBLEM NO. 2 – Lady Han Cookie Corporation .

You gathered the following information related to the Patents account of the Lady Han Cookie Corporation in
connection with your audit of the company’s financial statements for the year 2019.
In 2018, Lady Han developed a new machine that reduces the time required to insert the fortunes into its fortune
cookies. Because the process is considered very valuable to the fortune cookie industry, Lady Han patented the
machine.
The following expenses were incurred in developing and patenting the machine:
Research and development laboratory expenses P1,000,000.00
Metal used in the construction of the machine 320,000.00
Blueprints used to design the machine 128,000.00
Legal expenses to obtain patent 480,000.00
Wages paid for the employees’ work on the research, development, and building of the 1,200,000.00
machine (60% of the time was spent in actually building the machine)
Expense of drawing required by the patent office to be submitted with the patent application 68,000.00
Fees paid to the government patent office to process application 100,000.00
During 2019, Lady Han paid P150,000 in legal fees to successfully defend the patent against an infringement suit by
Cookie Monster Corporation.
It is the company’s policy to take full year amortization in the year of acquisition.
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Questions:
1. Cost of patent
2. Cost of machine
3. Amount that should charge to expense when incurred in connection with the development of the patented machine
4. Carrying amount of patent as of December 31, 2019
Legal expenses to obtain patent P 480,000.00
Expense of drawing required by the patent office 68,000.00
Fees paid to the government patent office 100,000.00
1.) Cost of patent P648,000.00
Metal used in the construction of the machine P 320,000.00

Blueprints used to design the machine 128,000.00
Wages paid to the employees (P1,200,000 x 60%) 720,000.00
2.) Cost of machine P1,168,000.00
Research and development laboratory expenses P1,000,000.00

Wages paid to the employees (P1,200,000 x 40%) 480,000.00
3.) R & D expense P1,480,000.00
Cost of patent(see no.1) P648,000.00

Less amortization up to 12/31/06 (P648,000 x 2/20) 64,800.00
4.) Carrying amount of patent, 12/31/19 P583,200.00
PRACTICAL PROBLEM NO. 3 – Bekenemen Company .

On January 2, 2012, Bekenemen Company spent P480,000 to apply for and obtain a patent on a newly developed
product. The patent had an estimated useful life of 10 years.
At the beginning of 2016, the company spent P144,000 in successfully prosecuting an attempted patent infringement.
At the beginning of 2017, the company purchased for P280,000 a patent that was expected to prolong the life of its
original patent by 5 years.
On July 1, 2020, a competitor obtained rights to a patent that made the company’s patent obsolete.
Questions:
Based on the above and the results of your audit, determine the following:
1. Carrying amount of the patent as of December 31, 2016.
2. Amortization of patent in 2017.
3. Carrying amount of the patent as of December 31, 2019.
4. Loss on patent obsolescence in 2020.
Suggested Solution:
Cost of patent P480,000.00
Less: Amortization up to 12/31/16 (480,000*5/10) (240,000.00)
1.) Carrying amount of patent, 12/31/16 P240,000.00
Amortization on original patent (240,000/10) P24,000.00
Amortization on related patent (280,000/10) 28,000.00
2.) Total amortization in 2017 P52,000.00
Original patent (P240,000*7/10) P168,000.00
Related patent (P280,000*7/10) 196,000.00
3.) Carrying amount of patents, 12/31/19 P364,000.00
Carrying amount of patents, 12/31/19 P364,000.00
Less: Amortization, 1/1/10 to 7/1/10:
Original patent (P240, 000/10*6/12) P12,000.00
Related patent (P280, 000/10*6/12) 14,000.00 (26,000.00)
4.) Loss on patent obsolescence P338, 000.00
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PRACTICAL PROBLEM NO. 4 – Pink Corporation .
Transactions during 2018 of the newly organized Pink Corporation included the following:
Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to complete organization of the
corporation.
15 Hired a clown to stand in front of the corporate office for 2 weeks and hound out pamphlets and
candy to create goodwill for the new enterprise. Clown cost, P10,000; pamphlets and candy, P5,000.
Apr. 1 Patented a newly developed process with costs as follows:
Legal fees to obtain patent P429,000.00
Patent application and licensing fees 63,500.00
Total P492,500.00
It is estimated that in 6 years other companies will have developed improved processes, making the
Pink Corporation process obsolete
May 1 Acquired both a license to use a special type of container and a distinctive trademark to be printed
on the container in exchange for 6,000 shares of Pink’s no-par common stock selling for P50 per
share. The license is worth twice as much as the trademark, both of which may be used for 6 years.
July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be developed in
future research projects.
Dec. 31 Incurred salaries for an engineer and chemist involved in product development totaling P1,750,000
in 2018.
Questions:
1. Cost of patent
2. Cost of licenses
3. Cost of trademark
4. Carrying amount of Intangible Assets
5. Total amount resulting from the foregoing transactions that should be expensed when incurred
Suggested Solution:
Journal entries for 2018:

1/02 Organization expenses 233,000
Cash 233,000
1/15 Advertising expense 15,000

Cash 15,000
4/01 1.) Patents 492,500

Cash 492,500
5/01 2.) Licenses (P300,000 x 2/3) 200,000

3.) Trademark 100,000
Common stock(6,000xP50) 300,000
7/1 Building 1,310,000

Cash 1,310,000
12/31 Research and Development expense 1,750,000

Cash 1,750,000
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Cost
Patent P492,500.00
Licenses 200,000.00
Trademark 100,000.00 P792,500.00
Less: Amortization
Patent (P492,500/6 x 9/12) P 61,563.00
Licenses(P200,000/6x 8/12) 22,222.00
Trademark(P100,000/6x8/12) 11,111.00 ( 94,896.00)
4.) Carrying value, 12/31/04 P 697,604.00
Organization expenses (Jan. 2 transaction) P233,000.00

Advertising expense (Jan. 15 transaction) 15,000.00
R and D expense (Dec. 31 transaction) 1,750,000.00
5.) Total P1,998,000.00
PRACTICAL PROBLEM NO. 5 – Silver Corporation .

On December 31, 2004, Silver Corporation acquired the following three intangible assets:
 A trademark for P300,000. The trademark has 7 years remaining legal life. It is anticipated that the trademark
will be renewed in the future, indefinitely, without problem.
 Goodwill for P1,500,000. The goodwill is associated with Silver’s Hayo Manufacturing reporting unit.
 A customer list for P220,000. By contract, Silver has exclusive use of the list for 5 years. Because of market
conditions, it is expected that the list will have economic value for just 3 years.
On December 31, 2005, before any adjusting entries for the year were made, the following information was assembled
about each of the intangible assets:
a) Because of a decline in the economy, the trademark is now expected to generate cash flows of just P10,000 per
year. The useful life of trademark still extends beyond the foreseeable horizon.
b) The cash flows expected to be generated by the Hayo Manufacturing reporting unit is P250,000 per year for the
next 22 years. Book values and fair values of the assets and liabilities of the Hayo Manufacturing reporting unit
are as follows:
Book values Fair values
Identifiable assets P2,700,000 P3,000,000

Goodwill 1,500,000 ?
Liabilities 1,800,000 1,800,000
c) The cash flows expected to be generated by the customer list are P120,000 in 2006 and P80,000 in 2007.
Questions:
Based on the above and the result of your audit, determine the following: (Assume that the appropriate discount rate
for all items is 6%):
1. Total amortization for the year 2005
2. Impairment loss for the year 2005
3. Carrying value of Trademark as of December 31, 2005
4. Carrying value of Goodwill as of December 31, 2005
5. Carrying value of Customer list as of December 31, 2005
Trademark* -
Goodwill* -
Customer list (P220,000/3) P73,333.00
1.) Total amortization P73,333.00
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Trademark:
Carrying value 300,000
Recoverable amount (P10,000/0.06) 166,667
P133,333.00
Goodwill*:
Carrying value of Hayo Manufacturing unit
(P2,700,000 + P1,500,000 - P1,800,000) 2,400,000
Recoverable amount (P250,000 x 12.0416) 3,010,400 -
Customer list
Carrying value (P220,000 - P73,333) 146,667
Recoverable amount:
2006: (P120,000 x 0.9434) 113,208
2007: (P80,000 x 0.8900) 71,200 184,408 -
2.) Total impairment loss P133,333.00
Cost P300,000.00
Less: Impairment loss (133,333.00)
3.) Carrying value, 12/31/05 P166,667.00
4.) Since goodwill is not amortized and is not impaired as of 12/31/05,

The carrying value is P1,500,000.
Cost P220,000.00
Less: Amortization for 2005 (73,333.00)
5.) Carrying value, 12/31/05 P146,667.00
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OUTLINE
1. Introduction
1.1 Why Audit Liabilities
1.2 Audit Objectives
1.3 Internal Control Measures for Liabilities

2.1. Reconciling general Ledger and subsidiary ledger
2.2. Performing purchase and accounts payable cut-off
2.3. Confirming liabilities to debtors
2.4. Inspecting supporting documents such as contracts, invoices receiving reports, etc.
2.5. Searching for unrecorded liabilities
2.6. Testing the accuracy of interest expense, interest payable, amortization of discount and premium
2.7. Evaluating proper financial statement presentation and adequacy of disclosures

3.1. Liabilities Denominated in Foreign Currencies
3.2. Reviewing compliance with terms of debt agreements
3.3. Accruals
3.4. Searching for contingent Liabilities
3.5. Reviewing early Retirement or Restructuring of Debt
4.1. IX Corporation – Deferred Tax
4.2. UNO Corporation – Contingent liability
4.3. PPG Inc. – Contingent liability
4.4. KERR Corporation – Restructuring
4.5. VV Corp. – Contingent liability
5.1. Current and Non-Current Liabilities
5.2. Bonus
5.3. Premiums
5.4. Employee Benefits
5.5. Sale and Leaseback
5.6. Accounting for Warrants and Premiums
5.7. Bond Redemption Prior to Maturity Date
5.8. Classifying Liabilities
5.9. Operating Lease
5.10. Deferred Income Tax Asset and Liability
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AUDIT OF LIABILITIES
Introduction
Liabilities represent obligation of an entity arising from past transactions or events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
Why Audit Liabilities?

Payables are one of the more important audit areas. Why? The reason is because of the RISKS. Unrecorded
liabilities, expense fraud, duplicate payments and no clear separation of accounting duties are some of the risks that
may be concealed along the audit trail in a company’s Accounts Payable Department. Undetected and uncontrolled,
they can damage a business’ success, competitiveness, and longevity.
Without effective internal controls and auditing standards for every stage of the procure-to-payment process,
a company is exposed to excessive risks.
Audit Objectives
 To obtain complete documentation of actual obligations held by the client, including current liabilities and
unprocessed invoices for products and services received but not billed as of period end.
 To confirm entry amounts provided by accounts payable match paired invoices, purchase orders, and other
supporting documentation and that all transactions are correctly recorded with regard to account, amount, and
period.
 To ensure that liabilities and related accounts are properly classified, described, and disclosed.
Internal Control Measures for Liabilities

 For Accounts Payables
o proper system of requisitioning, order placement and approval, receiving, invoice approval, and approval
for payment should be well-defined and established
o Subsidiary accounts payable records or unpaid vouchers should be reconciled with controlling accounts
at frequent intervals
o Check mathematical accuracy of suppliers’ invoices prior to recording
o Adjustments to accounts payable should be properly approved
o Debit balances in accounts payable should be reviewed and resolved
 For Notes Payable
o Borrowings on notes payable should be properly authorized. Specify the institutions from which the money
may be borrowed and designate the officers authorized to sign notes
o Unissued notes should be properly safeguarded
o Subsidiary notes payable records should be reconciled with controlling account at frequent intervals
o Paid notes should be properly cancelled and preserved
 For Long-Term Liabilities
o Long-term obligation should be properly authorized by the BOD or by a required majority of the
shareholders
o There should be proper control over issued and unissued obligations as in bonds, by an independent
bong trustee or transfer agent
o Redeemed bonds should be cancelled, properly mutilated, and retained for audit to prevent unauthorized
issuance
o Bond ledger should be used in which details of bond issued, cancelled and outstanding are shown. A
subsidiary bondholder’s ledger should also be maintained by the issuing corporation or the bond trustee
for bonds registered, as to principal and interest
o Proper control should be exercised over the payment of interest on long-term. Payment may be done by
an independently engaged interest-paying agent.
1. Reconciliation of Subsidiary Ledger with General Ledger

Reconciliation of Subsidiary Ledger with General Ledger Reconciliation is an internal control procedure that helps
ensure account balances in the general ledger are materially correct. The reconciliation process partially requires the
balance of the subsidiary ledger agree with the corresponding balance in the general ledger.
The auditor should test the accuracy of the balances thru footing/cross-footing. Through this procedure, an auditor
can then determine whether the liability figure is presented in the financial statement agrees with the detailed records.
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2. Purchase and Accounts Payable Cut-off
Most vendors have their own billing cycles which helps the accounting know when to expect what bills. The purpose
of cut-off tests is to verify that the transactions are completely recorded and are accounted for in the right period. The
auditor tests the accounts payable cut-off by examining invoices and other documentations supporting the transactions
recorded in purchase journal and cash disbursement journal immediately before and after the reporting date.
3. Confirmation of Liabilities to Debtors

Auditor confirmation of accounts payable balances at the reporting date may be unnecessary because there is
likely to be other reliable external evidence to support the balances. However, there are some cases where it may be
appropriate to request confirmation from vendors for balances owed.
These are the following:
 Controls over recording of invoices and receiving reports are ineffective;
 There are few transactions involving large amounts;
 There are numerous old balances.
4. Inspection of Supporting Documents
Vouching selected entries in the voucher register to supporting invoices, receiving orders, and purchase orders
provide evidence of the existence assertion. For lease liability, an auditor should examine the lease contract during the
current year to determine whether they are appropriately classified and whether finance lease obligations are
appropriately recorded and required disclosures are made. For notes payable and other obligations, the auditor should
inspect client’s copies of loan agreements or lending arrangements to obtain an understanding of the pertinent
provisions and to extract information relevant to the disclosures in the financial statements.
The auditor should also contact the lender/legal counsel for the entity with respect to the interpretation of terms,
restrictions, and other information that may be sought regarding special provisions
5. Search for Unrecorded Liabilities

The audit procedure performed at the end of the year determining whether all liabilities are recorded is called
search for unrecorded liability. This audit procedure is based on the premise that the company usually avoids the
recording of transaction related to liabilities but do not avoid making payments for them. A client who may understate
these liabilities is trying to produce a balance sheet that looks more attractive.
This audit procedure for liabilities is a fundamental, almost universally applied procedure in all audits.
 Audit objectives:
 Completeness. Ensuring that all the liabilities the business held as of the end of the period are included
in the financial statements.
 Obligations. All liabilities reported in the statement of financial position represent obligations of the entity
at the reporting date.
 Procedures:
a. Examine files of unpaid or unrecorded invoices, unmatched purchase orders, and unmatched receiving
reports and trace it to the related journal to determine it was properly recorded
b. Examine significant recorded purchases between the reporting date, and the date of search for
unrecorded liabilities to determine if this purchases should be properly included in the current year
financial statement
c. Obtain and review minutes of meetings and inspect contacts to identify unrecorded liabilities.
d. Review cash disbursements subsequent to the reporting date and check whether this may represent a
liability that should be reported on the current year
e. Request the client to make an appropriate adjusting entry for unrecorded liability identified by the
auditor
6. Test the Computation of Interest expense, Interest Payable, and Amortization Discount and Premium
 Audit Objectives:
 Valuation. The assertion is that all liabilities have been recorded at their proper valuations.
 Accuracy. The assertion is that the full amounts of the liabilities were recorded, without error.
 Procedures:
a. Obtain the interest rate (effective or nominal rate)
b. Re-compute the interest expense and interest payable
In order to verify the reasonableness of interest expense recorded, we used the following formula:
Principal x Average Interest Rate x Period = Interest Expense
Note: For Long-term Debts initially issued at a discount or premium, the auditor re-computes the amount by
preparing an amortization table and compares it with the amounts recorded.
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7. Evaluate Proper Financial Statement Presentation and Adequacy of Disclosure of Debt and Related
Transactions
 Audit Objective:
 Presentation and Disclosure. Ensuring that all debt and related transactions are properly classifies
described and discloses in the financial statements.
The auditor should make sure that the liabilities are properly disclosed on end-of-year financial a statement is the
final step in the auditing process of liabilities. Ways in which auditors accomplish this step include inspecting financial
statements to verify, for example, that accounts payable is listed as a current liability and that purchases are included
in cost of goods calculations. Auditors also take notice of footnotes that provide details for unusual transactions that
may require a more full explanation than can be provided by simply recoding the transaction.
OTHER AUDIT CONSIDERATIONS
1. Liabilities Denominated in Foreign Currencies

 Audit Objective:
 Valuation. To ensure that the liabilities denominated in foreign currencies are recorded at the appropriate
amounts
When preparing the annual financial statements, companies are required to report all transactions in their home
currency to make it easy for all stakeholders to understand the financial reports. This means that all transactions carried
out in foreign currencies must be initially converted to the home currency at the current exchange rate when the
business recognizes the transaction.
At the reporting date, the auditor will normally obtain the closing rate and re-performs the translation of the foreign
currency denominated payable. The difference between the initial rate used and the closing rate is recognized as gain
or loss.
Foreign currency transaction gains or losses are recognized in the financial statements in the period in which the
exchange rate changes. These gains or losses are reported on the income statement.
2. Review Compliance with the Term of Debt Agreement

The auditor should review the entity’s compliance with terms, restrictive covenants or other provisions of debt
agreements to determine whether violation of any debt covenants has occurred. Debt covenants are agreements
between a company and its lenders that the company will operate within certain rules set by the lenders. They are also
called banking covenants or financial covenants. If there has been a default or violation, the auditor should ensure that
this is properly disclosed in the notes and the item should be presented as current liability in the statement of financial
position.
3. Accruals
Accruals occur where the expenditure has been incurred in the current period but not yet paid. Unlike regular
accounts payable, at the time of recording the accrual, supporting documents (e.g., receipts) are not available yet. With
that, there are the following procedures that the auditor should observe:
 Procedures:
 Obtain detailed listings of accruals to reconcile to GL or TB: Auditor should obtain detailed listings of
accruals of the Company to reconcile with financial statements for the period of auditing.
 Assess the reasonableness of management’s assumptions used in the assessment of accruals.
 Compare estimates made in prior periods with actual results for those periods.
 Determine whether accounting estimates made by the management of the Company in this area
represent a risk of material misstatement (overstate or understate).
4. Searching for contingent Liabilities
Three conditions are required for a contingent liability to exist:
 There is a potential future payment to an outside party
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 There is uncertainty about the amount of the future payment or impairment
 The outcome will be resolved by some future event or events
Likelihood of Occurrence of Event Financial Statement Treatment
Remote (slightly chance) No disclosure is necessary

Reasonably possible (more than remote but less Footnote disclosure is necessary
than probable)
Probable (likely to occur) 1. If the amount can be reasonably estimated,
financial statement accounts are adjusted.
2. If the amount cannot be reasonably estimated,
footnote disclosure is necessary.
Auditors are especially concerned about certain pending contingent liabilities:

 Pending litigation for patent infringement, product liability, or other actions
 Income tax disputes
 Product warranties
 Guarantees of obligation of others
The one who is responsible for identifying and deciding on the appropriate accounting treatment for contingent
liabilities is not the auditor, but the management itself. On the other hand, the auditors’ primary objectives in verifying
contingent liabilities are the following:
o Classification Presentation and Disclosure. Evaluate the accounting treatment of known contingent liabilities
to determine whether the management has properly classified the contingency.
o Completeness Presentation and Disclosure. Identify to the extent practical any contingencies not already
identified by management.
 Audit Procedure for Finding Contingencies:
When a contingent liability falls in the reasonable possible category or probable category the contingent loss
would be disclosed in all financial statements or recorded. If the liability has the potential to cause the company a
huge loss the company may not want to disclose this information.
a. Inquire of management about the possibility of unrecorded contingencies. However, for intentional cover-
ups, this is not an effective method.
b. Review the minutes of directors’ and stockholders’ meeting for indication of lawsuits or other
contingencies.
c. Analyze legal expenses for the period under audit
d. Obtain a letter from each major attorney performing legal services for the client as to the status of pending
litigation or other contingent liability. The auditor will ask the client to send letters of audit inquiry to lawyers
with whom the client has consulted concerning these matters. The letter, which should be prepared by
the management and sent by the auditor, should request the lawyer to communicate directly to the auditor.
5. Reviewing early Retirement or Restructuring of Debt
The auditor should review an early retirement of debt or a restructuring of debt to determine whether a gain or loss
on the transaction should be recognized. The audit should ensure as well if they are appropriately calculated, accounted
for and disclosed in accordance with the applicable PFRSs.
SITUATIONAL PROBLEM NO. 1 – IX Corp. .

Year end of one of your client (IX Corp.) is December 31, 20×8. In February 20×9, before the accounts were
approved, the Government announced increase in tax rates by 10%. The liability for deferred tax has been adjusted
by the increase in tax rates. The amount involved is material. What will be the impact on your audit report for year
ended December 31,20×8?
One of the examples of non-adjusting events per IAS 10 states: “Changes in tax rates or tax laws enacted or
announced after the balance sheet date and has a significant effect on current and deferred tax assets
and liabilities.” Since there is no present obligation at year end, no provision should have been made. The report
will be qualified if the client does not reverse the provision.
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SITUATIONAL PROBLEM NO. 2 – UNO Corp. .
You are manager in-charge for the audit of UNO Corp. During audit you noticed that the company was sued
for breach of contract by a customer claiming damages of 200 million. Based on the lawyer’s opinion (received
through management), the management asserted that there would be no significant liability at the balance
sheet date in respect of the said breach and accordingly, no provision was made in the financial statements.
However, while studying the case file you found a memorandum from the head of the legal department addressed
to the managing director in which he had opened that the company will have to pay at least 50% of the damages
claimed.
You concluded that this note was a strong evidence indicating the existence of this liability, which should be
provided for. Management considers that such note was nullified by the opinion of the company’s legal advisor and
as such there was no need to make any provision in respect of this contingent liability that was considered to be
remote. Therefore, the CFO advises you that at the most there may be a disclosure of this contingent liability in
the financial statement of perhaps an emphasis of matter paragraph in the auditor’s report without qualification.
What is your conclusion and recommendation for the decision of the partner as to the type of opinion that
should be issued and why?
1. A provision is required under the circumstances as outflow of economic resources is probable and the
amount can be estimated reliably.
2. A qualified opinion is required on the grounds of disagreement with management.
SITUATIONAL PROBLEM NO. 3 – PPG Inc. .

ALV Inc. is a key supplier of raw materials to PPG Inc. ALV has filed a suit against PPG, for breach of terms
of an agreement. The amount claimed by ALV is 10 million. PPG has disclosed it as a contingent liability in the
draft financial statements for the year ended 31 December 2019. However, PPG is striving for a court
settlement and recent correspondence indicates that ALV is likely to agree and settle the dispute for 50% of the
amount claimed by them.
Requirement:
Describe the audit procedures that PPG’s auditor should perform in the above situation. Also discuss the
impact, if any, of the above procedures on the audit report.
Perform following audit procedures to conclude whether a provision is required:
1. Inspect correspondence with PL to ascertain probability of settlement of claim.
2. Seek opinion of entity’s lawyers for the estimated amount involved.
3. Obtain written representation from management, If the management refuses to make appropriate provision
as the auditor considers necessary the report should be qualified.
SITUATIONAL PROBLEM NO. 4 – KERR Corp. .

You are the auditors of KERR Corporation for year ended December 31, 20×8. On December 10, 20×8, the
management decided for restructuring and closing down a division. The decision was communicated to
those affected on January 15, 20×9 and no other steps were taken to implement the decision. KERR has made
provision of 5 million representing approximate costs for closure of division. Your independent estimate of cost
works out to 9 million. What will be the impact on audit report?
At December 31, 20×8 there was no obligating event and no provision should have been made. Provision on
contingent assets and contingent liabilities provides that a provision is recognized only when there is present
obligation as a result of past events. A Provision for restructuring may be made only when an entity has announced
the main features to those affected by it. If the management does not reverse the provision, a qualified opinion will
be issued.
SITUATIONAL PROBLEM NO. 5 – VV Corp. .
VV Corp. has submitted its financial statements for the year ended December 31, 20×8 for audit any has the
company not made any provision relating to following, but. has disclosed the facts as contingent liabilities:
(a) Two law suits have been filed against the company during the year for 2 million and 3.5 million respectively.
The Company’s legal counsel is of the view that an unfavorable decision is unlikely in the case of claim of
3.5 million; however, the court verdict against the company of l.5 million is probable in the suit of 2 million.
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(b) In September 20×8, the company was identified as one of the potentially responsible parties to an oil spill
into the sea from an oil tanker on which the oil of the company was being imported. The company’s management
believes that it is not probable the company would be responsible for these damages. A reasonable estimate
of damages is 2.5 million.
(c) A damages claim of 15 million for breach of contract has been served on the company. The company’s
legal counsel is of the view that it is possible that the damages will be awarded to the plaintiff. – However, the
amount of damages cannot be reasonably estimated. Indicate how would you treat the effect of above in your audit
report. None of the above has been provided.
(a) For the law suit of 2 million, there is a present obligation and an outflow of resources embodying economic
benefits in settlement probable.
o A provision is required for 1.5 million. The report will have to be qualified.
o For the law suit of 3.5 million, there is no obligation as a result of past events. No provision is required.
(b) There is no obligation as a result of past events. No provision is required. The matter is rightly disclosed
as contingent liability.
(c) The outflow of economic resources is possible. However, since: the amount cannot be measured with
sufficient reliability, a disclosure of contingent liability will be in order.
PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO. 1 – ECG Company (Current and Noncurrent Liabilities) .

An Analysis of EGG Company’s liabilities on December 31, 2019 disclosed the following information:
Accounts Payable (after deducting debit balances in supplier’s accounts amounting to 4,000,000
100,000 and postdated checks of 50,000)
Bonds Payable 1,000,000
Premium on bonds payable 100,000
Mortgage payable 850,000
Share dividends payables 750,000
Credit balances in cutomers’ accounts 500,000
Premium payable 600,000
Deferred tax liability 200,000
Deferred Revenue 175,000
Accrued Expenses 150,000
The deferred tax liability is based on temporary differences that will reverse in 2020.
Questions:
1. What is the amount of current liabilities in the statement of financial position?
2. What is the amount of non-current liabilities in the statement of financial position?
Accounts payable–unadjusted 4,000,000
Add/(Deduct): Adjustments
Debit balances in suppliers’ accounts 100,000
Postdated checks of 50,000 50,000
Accounts payable–adjusted 4,150,000
Credit balances in customer’s accounts 500,000
Premiums payable 600,000
Accrued expenses 150,000
Total current liabilities 5400,000
Bonds Payable 1000,000

Premium on bond payable 100,000
Mortgage payable 850,000
Deferred tax liability 200,000
Deferred Revenue 175,000
Total non-current liabilities 2325,000
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PRACTICAL PROBLEM NO. 2 – Krusty Krab Company (Bonus) ..
Mr. Krabs, president of the Krusty Krab Company, has a bonus arrangement with the company under which he receives
10% of the net income (after deducting taxes and bonuses) each year.
For the current year, the net income before deducting either the provision for income taxes or the bonus is P4,650,000.
The bonus is deductible for tax purposes, and the tax rate is 32%.
Questions:
1. What is the amount of Mr. Krabs’s bonus is?
2. What is the appropriate provision for income tax for the year is?
3. What is the entry to record the bonus (which will be paid in the following year) is?
Question No. 1
B = 10% (P4,650,000 – B – T)
T = 32% (P4,650,000 – B)
B = 10% {P4,650,000 – B – [32% (P4,650,000 – B)]}
B = 10% [P4,650,000 – B – (P1,488,000 - .32B)]
B = 10% (P4,650,000 – B – P1,488,000 + .32B)
B = P465,000 - .10B – P148,800 + .032B
B = P316,200 - .068B
1.068B = P316,200
B = P296,067.42
Question No. 2
T = 32% (P4,650,000 – P296,067.42)
= P1,393,258.43
Question No. 3
Bonus expense 296,097.42
Bonus payable 296,097.42
PRACTICAL PROBLEM NO. 3 – Kopiko Company (Premiums) .

Kopiko Company started a promotional campaign on June 30, 2019. Kopiko placed a coupon redeemable for a premium
in each package of product sold. Each premium costs P100. A premium is offered to customers who send in 5 coupons
and a remittance of P30. The distribution cost per premium is P20. Kopiko estimated that only 60% of the coupons
issued will be redeemed.
For the six months ended December 31, 2019, the following is available:
Packages of coffee sold 160,000
Premiums purchased 16,000
Coupons redeemed 64,000
Question:
1. How much is Kopiko Company’s estimated liability for coupons on 12/31/19?
Suggested Solution:
Estimated coupons to be redeemed (160,000x 60%) 96,000
Less coupons redeemed 64,000
Coupons outstanding 32,000
Divide by exchange rate / 5
Premiums to be issued 6,400
Multiply by net premium cost (100 + 20 - 30) X 90
Estimated liability for coupons, 12/31/19 576,000
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PRACTICAL PROBLEM NO. 4 – Chum Bucket Inc. (Employee Benefits) .
The following information relates to the defined benefit pension plan of the Chum Bucket Inc. for the year ended
December 31, 2019:
Projected benefit obligation, January 1 13,800,000
Projected benefit obligation, December 31 13,150,000
Fair value of plan assets, January 1 11,500,000
Fair value of plan assets, December 31 13,600,000
Unrecognized past service cost, January 1 500,000
Unrecognized net actuarial loss, January 1 1,300,000
Contribution to the plan 2,000,000
Benefits paid to retirees 1,800,000
Amortization of past service cost 100,000
Actuarial change decreasing PBO 906,000
Present value of available refunds and reductions in future
contribution to the plan 250,000
Expected return on plan assets 14%
Settlement rate 12%
Expected average remaining working lives of the employees
participating in the plan 10 years
Questions:
1. What is the current service cost for 2019?
2. What is the actual return on plan assets in 2019?
3. What is the unrecognized net actuarial loss as of December 31, 2019?
Question No. 1
Projected benefit obligation, January 1,2019 P13,800,000
Current service cost (squeeze) 400,000
Interest cost (P13,800,000 x 12 %) 1,656,000
Actuarial change decreasing PBO (906,000)
Benefits paid to retirees (1,800,000)
Projected benefit obligation, December 31,2019 P13,150,000
Question No. 2
Fair value of plan assets, January 1 ,2019 P11,500,000
Actual return on plan assets (squeeze) 1,900,000
Contribution to the plan 2,000,000
Benefits paid to retirees (1,800,000)
Fair value of plan assets, December 31,2019 P13,600,000
Question No. 3
Unrecognized net actuarial loss, January 1,2019 1,300,000
Actuarial change decreasing PBO (906,000)
Difference between actual and expected return on plan assets
[P1,900,000 - (P11,500,000 x 14%)] (290,000)
Unrecognized net actuarial loss, December 31,2019 P104,000
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PRACTICAL PROBLEM NO. 5 – WAFFLES Company (Sale and Leaseback) .
The following data relate to a sale and leaseback of equipment of WAFFLES Company on December 31, 2018:
Sales Price (equal to PV of rentals) P1,000,000
Cost of Equipment 1,400,000
Annual rent Payable 240,000
Estimated remaining life 5
Lease term 5
Implicit rate 10%
Question:
1. Compute for any gain/loss and prepare the journal entries
Loss on sale and leaseback
Sales price P1,000,000
Less: Carrying Amount (1,400,000- 1,300,000
100,000)
Loss on sale and leaseback) (300,000)
Journal Entries:
12/31/2018 Cash 1,000,000
Loss on sale and leaseback 300,000
Equipment 1,400,000
12/31/2018 Equipment 1,000,000
Lease Liablity 1,000,000
PRACTICAL PROBLEM NO. 6 – ALEX Music Emporium (Accounting for Warranties and Premiums) .
ALEX MUSIC EMPORIUM carries a wide variety of musical instruments, sound reproduction equipment, recorded
music and sheet music. To promote the sale of its products, Alex uses two promotion techniques – premiums and
warranties.
PREMIUMS
The premium is offered on the recorded and sheet music. Customers receive a coupon for each P10 spent on
recorded music and sheet music. Customers may exchange 200 coupons and P200 for a CD player. Alex pays P340
for each CD player and estimates that 60% of the coupons given to customers will be redeemed. A total of 6,500 CD
players used in the premium program were purchased during the year and there were 1,200,000 coupons redeemed
in 2018.
WARRANTIES
Musical instruments and sound reproduction equipment are sold with a one-year warranty for replacement of
parts and labor. The estimated warranty cost, based on past experience, is 2% of sales. Replacement parts and
labor for warranty work totaled P1, 640,000 during 2018.
Alex uses the accrual method to account for the warranty and premium costs for financial reporting purposes. Alex’s
sales for 2018 totaled P72,000,000-P54,000,000 from musical instruments and sound reproduction equipment and
P18,000,000 from recorded music and sheet music. The balances in the accounts related to warranties and premiums
on January 1, 2018, were shown as below:
Inventory of premium CD players P 399,500
Estimated premium claims outstanding 448,000
Estimated liability from warranties 1,360,000
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Questions:
Based on the preceding information, determine the amounts that will be shown on the 2018 financial statements for
the following:
1. Warranty Expense
2. Estimated Liability from warranties
3. Premium Expense
4. Inventory of premium CD players
5. Estimated Premium claims outstanding
1.) Warranty Expense – 2018
Sales of musical instruments and sound reproduction equipment P 54,000,000
Estimated warranty cost X 2%
Warranty Expense for 2018 P1,080,000
2.) Estimated Liability from warranties

Estimated liability from warranties, Jan. 1, 2018 P1,360,000
Add: 2018 Warranty Expense (no.1) 1,080,000
TOTAL 2,440,000
Less: Actual warranty costs during 2018 1,640,000
Estimated Liability from warranties, Dec 31, 2018 800,000
3.) Premium Expense

Coupons issued (18.000,000/10) 1,800,000
Multiply by estimated redemption rate x 60%
Estimated number of coupons to be redeemed 1,080,000
Divide by exchange rate (200 coupons for a CD player) ÷ 200
Estimated number of CD players to be issued 5,400
Multiplied by net cost of a CD player (P340-P200) X 140
Premium Expense for 2018 756,000
4.) Inventory of premium CD players

Inventory of premium CD players 399,500
Add: Premium CD players purchased during 2018 (340x6,500) 2,210,000
TOTAL 2,609,500
Less: Premium CD players distributed to customers during 2018 2,040,000
(1,200,000/200=6,000x340)
Inventory of premium CD players, Dec 31, 2018 569,500
5.) Estimated premium claims outstanding

Estimated premium claims outstanding, Jan 1, 2018 448,000
Add: 2018 premium expense (no.3) 756,000
TOTAL 1,204,000
Less: 2018 actual redemptions (1,200,000/200=6,000x140) 840,000
Estimated premium claims outstanding, Dec. 31, 2018 364,000
PRACTICAL PROBLEM NO.7 – SAM COMPANY (Bond Redemption Prior to Maturity Date) .
The long-term debt section of Sam Company’s Statement of Financial Position as of December 31, 2017, included 9%
bonds payable of P400,000, less unamortized discount of P32,000. Further examination revealed that these bonds
were issued to yield 10%. The amortization of the bond discount was recorded using the effective interest method.
Interest was paid on January 1 and July 1 of each year. On July 1, 2018, Sam retired the bonds at 105 before maturity.
Question:
1. What is the amount of loss to be recognized on the retirement of bonds?
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Suggested Solution:
Effective interest (P400,000-P32,000=P368,000x10%x1/2) P18,400
Nominal Interest (P400,000x9%x1/2) 18,000
Discount Amortization, Jan 1, 2018- July 1, 2018 P400
Retirement Price (P400,000x105%) P420,000

Carrying value of Bonds:
Face Value 400,000
Less: Unamortized Discount (P32,000-P400) 31,600 368,400
Loss on retirement of bonds P51,600
PRACTICAL PROBLEM NO. 8- PINK CORP. (Classifying Liabilities) .

PINK CORP. has been producing quality disposable diapers for more than two decades. The company’s fiscal year
runs from April 1 to March 31. The following information relates to the obligations of PINK as of March 31, 2018.
BONDS PAYABLE
PINK issued P10,000,000 of 10% bonds on July 1, 2016. The prevailing market rate of interest for these bonds
was 12% on the date of issue. The bonds will mature on July 1, 2026. Interest is paid semiannually on July 1 and
July 31. PINK uses the effective interest rate method to amortize bond premium or discount.
The following present value factors are taken from the present value tables:
PV of 1 at 12% for 10 periods 0.32197
PV of 1 at 6% for 20 periods 0.31180
PV of an ordinary annuity of 1 at 12% for 10 periods 5.65022
PV of an ordinary annuity of 1 at 6% for 20 periods 11.46992
NOTES PAYABLE
PINK has signed several long-term notes with financial institutions. The maturities of these notes are given in
the schedule below. The total unpaid interest for all of these notes amounts to P600,000 on March 31,2018.
Due Date Amount Due
April 12, 2018 P400,000
July 1, 2018 600,000
October 1, 2018 300,000
January 1, 2019 300,000
April 1, 2019 – March 31, 2020 1,200,000
April 1, 2020– March 31, 2021 1,000,000
April 1, 2021– March 31, 2022 1,400,000
April 1, 2022– March 31, 2023 800,000
April 1, 2023– March 31, 2024 1,000,000
P7,000,000
ESTIMATED WARRANTIES
PINK has a one-year product warranty on some selected items in its product line. The estimated warranty liability
on sales made during 2016-2017 fiscal year and still outstanding as of March 31, 2017, amounted to P180,000. The
warranty costs on sales made from April 1, 2017 through March 31, 2018, are estimated at P520,000. The actual
warranty costs incurred during the current 2017-2018 fiscal year are as follows:
Warranty claims honored on 2016-2017 sales P180,000
Warranty claims honored on 2017-2018 sales 178,000
Total warranty claims honored P358,000
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OTHER INFORMATION:
1. TRADE PAYABLES
Accounts Payable for supplies, goods and services purchased on open account amount to P740,000 as of March
31, 2018.
2. PAYROLL RELATED ITEMS
Accrued Salaries and Wages P300,000
Withholding taxes payable 94,000
Other payroll deductions 10,000
TOTAL P404,000
3. MISCELLANEOUS ACCRUALS
Other accruals not separately classified amount to P150,000 as of March 31, 2018.
4. DIVIDENDS
On March 15, 2018, PINK’s Board of Directors declared a cash dividend of P0.20 per ordinary share and a 10%
share dividend. Both dividends were to be distributed on April 12, 2018, to the shareholders of record at the close
of business on March 31, 2018. Data regarding PINIK’s ordinary share capital are as follows:
Par Value P5.00
Number of shares issued and outstanding 6,000,000 shares
Market values of ordinary shares:
March 15,2018 P22.00per share
March 31,2018 21.50 per share
April 12,2018 22.50 per share
Questions:
1.) How much was received by PINK from the sale of bonds on July 1, 2016?
2.) What is the current portion of PINK’s Notes Payable at March 31, 2018?
3.) The balance of the estimated warranties payable at March 31, 2018 is?
4.) On March 31, 2018, PINK’s statement of financial position would report total current liabilities of?
5.) On March 31, 2018, PINK’s Statement of financial position would report total noncurrent liabilities of?
Question No. 1
PV of Principal (10,000,000x0.31180) P3,118,000
PV of interest payments 5,734,960
(P10,000,000x5%=P500,000x11.46992)
Issue Price/Proceeds P8,852,960
Question No. 2
April 1, 2019 P400,000
July 1, 2018 600,000
October 1,2018 300,000
January 1, 2018 300,000
TOTAL P1,600,000
Question No. 3
Bal, April1 , 2017 P180,000
Add: Warranty Expense for current year 520,000
TOTAL 700,000
Less: Actual warranty costs 358,000
Bal, March 31, 2018 342,000
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Question No. 4
Notes Payable- current portion (no.2) P1,600,000
Estimated warranties payable (no.3) 342,000
Accounts Payable 740,000
Payroll-related accruals and deductions withheld 404,000
Miscellaneous accruals 150,000
Cash dividends payable 1,200,000
Accrued interest on:
Bonds Payable (P10,000,000x10%x3/12) 250,000
Notes Payable 600,000
Total current liabilities 5,286,000
Question No. 5
AMORTIZATION SCHED (Partial)
Date Interest Paid Interest Expense Discount CA
Amortization
7/6/16 P8,852,000
12/31/16 P500,000 P531,178 P31,178 8,884,138
7/1/17 P500,000 533,048 33,048 8,917,186
12/31/17 P500,000 535,031 35,031 8,952,217
7/1/18 P500,000 537,133 37,133 8,989,350
Bonds Payable
Carrying Value, Jan 1, 2018 P8,952,000
Add: Discount Amortization, Jan 1- 18,566 P8,970,783
March 31 (37,133x3/6)
Notes Payable- noncurrent portion
(7,000,000-1,600,000 current portion) 5,400,000

TOTAL NONCURRENT LIABILITIES P14,370,783
PRACTICAL PROBLEM NO. 9 – CLOVER COMPANY (Operating Lease) .

On January 1, 2018, Clover Company entered into a five-year nonrenewable operating lease, commencing on that
date, for office space. The office space has a useful life of 50 years and the lease specifies a rent of P20, 000 per
month.
Assume the following independent cases:
1.) How much is the total rent expense in 2018?
2.) Assuming that the lessor grants nine months of free rent, how much is the total rent expense in 2018? How
much is the accrued rent payable or prepaid rent at the end of 2019?
3.) Assume instead that in the first two years, rent will be P20,000 per month but in the last three years, it will be
P25,000 per month. How much is the total rent expense in 2018? How much is the accrued rent payable or
prepaid rent at the end of 2019?
4.) Assume that lessee is paid P60,000 lease bonus to obtain the lease and security deposit of P40,000 to be
refunded upon expiration of the lease. How much is the total rent expense in 2018?
5.) Assume instead that the lessor paid initial direct cost of P60,000 and incurred insurance and property tax
expense in 2018 totaling P30,000. The depreciation of the office space for the year 2018 is P30,000. How
much is the net income to be recognized by the lessor as a result of this lease in 2018.
6.) Assume that in addition to the monthly rent of P20,000 per month, the lessor and lessee agreed on the
following terms:
Additional rent is computed at 6% of net sales over P1,500,000 up to P3,000,000 and 5% of net sales over
P3,000,000 per calendar year. Net sales for 2018 were P5,000,000.
Required: Compute for the total rent expense in 2018 for each of the above independent cases.
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Question No. 1
Monthly rental P20,000
Multiply by: number of months used in 2018 12
Rental Expense 2018 P240,000
Question No. 2
Total payments for the entire lease term (20,000x(60-9)) P1,020,000
Divide by: Lease term (in months) 60
Monthly rental expense 17,000
Multiply by: Number of months used in 2018 12
Rental Expense – 2018 P204,000
Accrued/Prepaid Rent as of December 31, 2019

Rental expense to date (2018 and 2019) P408,000
Less: Rental payments to date (20,000x15) 300,000
Accrued rent 12/31/2019 P108,000
Question No. 3
Total payments for the entire lease term
First two years (P20,000x24) P480,000
Next three years (P25,000x36) 900,000 P1,380,000
Divide by: Lease term in months 60
Multiply by: number of months used in 2018 12
Rental expense 2018 P276,000
Accrued/Prepaid rent as of December 31, 2019

Rental Expense to date (276,000x2yrs) P552,000
Less: Rental payments to date (P20,000x24) 480,000
Accrued rent payable 12/31/2019 P72,000
Question No. 4
Periodic payments
Multiply by: number of months used in 2018 12 P240,000
Lease bonus
Lease bonus P60,000
Divide by: Lease term in months 60
Multiply by: Number of months used in 2018 12 12,000
Total rent expense - 2018 P252,000
Question No. 5
Multiply by: Number of months leased out in 2018 12
Rental Income P240,000
Less: Expenses
Insurance and property tax expense P30,000
Depreciation expense (leased asset) 30,000
Amortization of initial direct cost (6,000/60x12) 1,200 61,200
Net Income 178,800
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Question No. 6
Periodic payments:
Multiply by: Number of months used in 2018 12 240,000
Contingent rent:
P1,500,000 to P3,000,000 at 6% P90,000
In excess of P3,000,000 at 5% 100,000 190,000
Total Rent Expense- 2018 P430,000
PRACTICAL PROBLEM NO.10 – PANCAKE INC (Deffered Income Tax Asset and Liability) .
PANCAKE INC., in its first year of operations, has the following differences between the carrying value and tax base
of its assets and liabilities at the end of 2018:
Carrying value Tax Base
Equipment (net) P800,000 P680,000
Estimated warranty liability 400,000 0
PANCAKE estimates that the warranty liability will be settled in 2019.
The difference in equipment (net) will result in taxable amounts as shown below:
Year Amount
2019 P40,000
2020 60,000
2021 20,000
The company has taxable income of P1,040,000 for 2018. The income tax rate is 30%
1.) What amount of deferred tax liability should be reported in PANCAKE’s statement of financial position at
December 31, 2018?
2.) What amount of deferred tax asset should be reported in PANCAKE’s statement of financial position at
December 31,2018?
3.) What is the amount of income tax payable (current) to be reported in PANCAKE’s statement of financial
position at December 31, 2018?
4.) What is the total income tax expense for 2018?
Question No. 1
Deferred Tax Liability. 12/31/2018 P36,000
(P40,000+60,000+20,000= P120,000x30%)
Question No. 2
Deferred Tax Asset, December 31,2018 P120,000
(P400,000x30%)
Question No. 3
Taxable Income for 2018 1,040,000
Tax rate 30%
Income tax payable 2018 P312,000
Question No. 4
Current tax expense 2018 P312,000
Deferred tax expense 2018 36,000
Deferred tax benefit 2018 (120,000)
Income tax expense 2018 P228,000
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OUTLINE
1. Introduction
1.1 Substantive Test of Shareholders’ Equity

2.1 Obtain and Verify Equity Reconciliation Schedule
2.2 Review Minutes of Meetings and Articles of Incorporation
2.3 Analyze Retained Earnings and Review Appropriateness of Dividends
2.4 Review Financial Statement Presentation and Disclosures of Shareholders’ Equity Items
2.5 Audit of Sole Proprietorship, Partnership and Other Types of an Entity
2.5.1 Procedures for Audit of Sole Proprietorships
2.5.2 Procedures for Audit of Partners’ Account
2.5.3 Procedures for Audit of Other Types of Entity
3.1 Umbrella Corp. – Limiting Audit Work to Independent Agents’ Confirmation
3.2 Ciri Corp. – Improper Recognition of the Cost of Share Options
3.3 Arkadia Corp. – Improper Presentation and Disclosure of Common Shares, Control Weaknesses
3.4 Winterfell Corp. – Verification of the Existence of Recorded Dividends in Retained Earnings
3.5 Arthdal Corp. – Verification of Treasury Share Account Encountered in Second Annual Audit
4.1 Monte Company
4.2 Tanya Company
4.3 Blue Company
4.4 Forge Inc.
4.5 Bangladdesh Company
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AUDIT OF SHAREHOLDERS’ EQUITY
Substantive Test of Shareholders’ Equity
The auditor should obtain an understanding of the business and industry and determine the entity’s need for
external financing and the desirability of using equity financing to support the growth of the entity.
The financing cycle involves the activities of the company that are designed to obtain capital funds. It typically
involves the issuance and repayments of debt and equity. The focus of substantive tests is on the changes in the
owner’s equity accounts, such as new stock issues, purchase or reissuance or treasury shares, prior period
adjustments, dividend payments and dividend declaration.
Audit Objectives
When auditing the components of shareholder’s equity, the principal objective for the substantive test is to
determine the following:
 Existence
 Completeness
 Valuation and allocation
1. Obtain and Verify Equity Reconciliation Schedule

Normally, few transactions but in large amount are involved in equity transactions so the auditor generally assesses
control risk at the maximum level for shareholders’ equity and other transactions. In examining the appropriateness
and proper authorization of equity transactions, the auditor should perform the following procedure:
 Obtain an equity reconciliation schedule (Statement of changes in equity).
 Agree to general ledger accounts
 Test movements from prior year end to current year end to verify proper accounting for changes in equity
 Determine that changes in equity have been authorized by the Board of Directors and appropriate
officers
 Determine completeness and compliance with applicable laws and regulation including taxation issues
 Treasury Shares transaction
Treasury shares are the shares which are bought back by the issuing company, reducing the number
of shares outstanding on the open market. All companies have an authorized amount of equity capital that it
can issue legally. For treasury shares transaction, the auditor should perform the following:
o Inspect the securities on hand and examine if it is under the name of the corporation
o Determine whether the reacquisition or reissuance was authorized y the BOD
o Determine the legal requirement on restriction of retained earnings acquiring treasury shares
o Determine whether the price or received consideration was in accordance with the price
specified by the BOD. For non-cash consideration, determine whether it was properly accounted
for under applicable PFRS or not.
 Other Comprehensive Income
For movements of OCI components, the auditor normally performs the following:
OCI COMPONENTS
Unrealized gain or loss
This can be verified in conjunction with the audit of the related investment by
on available for sale or
checking the change in fair value of the investment.
FVOCI
Effective portion of cash This can be verified in conjunction with the audit of related derivative
flow hedge instrument
This can be verified in conjunction with audit of the related PPE accounts
Recognition or change in
Piecemeal realization or revaluation surplus should be traced to the retained
revaluation surplus
earning account
This can be verified by inquiring to the management the date of transactions

Translation gain or loss affecting the balance reported in the financial statement, obtaining the
on foreign operation appropriate rate to be used; performing independent translation and
comparing it with the balance reported.
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This can be verified in conjunction with the audit of the related plan asset and
the benefit obligation
Actuarial gain or loss
employee benefits
This area is considered special in nature and the auditor may need the
assistance of an expert.
2. Obtain and review Board of Director’s (BOD) minutes of meetings, Shareholders meeting, Committee
meetings and Articles of Incorporation.
The auditor should review a copy of the client’s articles of incorporation. This document provides relevant
information with respect to each class of stock. Since most equity transactions require Board approval, the auditor
should review minutes of meeting committee meetings for approval and intent
Transfer agent is responsible for issuing and cancelling the entity’s shares or bond certificates and for maintaining
the records of share transfers. The registrar maintains the shareholders ‘register showing the names and addresses of
registered shareholders at any time
Independent registrars also verify that equity-related transactions are recorded correctly as to account (common
or preferred), dollar amount, and financial period, and that the equity section of the balance sheet is properly described
and disclosed. They advise their client about any recording issues so the company can adjust their books or make
disclosures.
When verifying these items, the auditor should consider whether the company maintains the shareholders record,
or the entity employs independent registrar and stock transfer agent since this will affect the audit procedures
performed.
 When these duties are performed by independent registrar and stock transfer agent. the auditor performs the
following audit procedure:
o Confirm the balance at year end and transactions during the year to the independent registrar and
agent
o Trace replies from the confirmation request to the corporate records
o Agree the general ledger controlling accounts to the amount of stock issued as reported by the
independent registrar and stock transfer agent.
 Confirmation request
When sending confirmation request, it should be written under the client’s letterhead and mailed the
auditors to prevent manipulation by the client. The content of the confirmation request includes the following
information:
o The total number of each class of shares issued and outstanding at the reporting date
o Details of any change in this amount during the year
o The number of shares outstanding at the record date if dividends have been declared
o The amount of an amount of any subscriptions receivable in respect of shares subscribed but not
issued
o Whether any shares are being reserved for future issuance
o The amount of any unclaimed dividends
o A list of principal shareholders for each class of shares
 When the entity maintains the shareholders records:
The auditor must adopt alternative procedure to obtain evidence that is not available by direct confirmation
with outside parties the auditor performs the following audit procedure:
o Account for the share certificate numbers, both for unissued and cancelled share certificate
o Check the details of share transactions during the year to minutes of the directors’ meeting to
determine that the transactions have been properly authorized.
o Reconcile the stock ledger from the supporting documents.
o Reconcile the shareholders ledger and share certificate book with the general ledger.
3. Review the appropriateness of Accounting for Share-based Payment Transactions
When understanding the client, its environment including its internal control, the auditor must obtain an overall
understanding of how management uses share-based payments to compensate employees, both currently and
historically, and the process that is undertaken to manage and administer awards-including the approval process.
Regardless of the assessment of the risk involving the process of granting shared-based compensation, the auditor
should perform the following audit procedure:
 Inquire management regarding the completeness and accuracy of stock option records, including the
designated grant dates.
 Review minutes of meetings of those charged with governance or the remuneration committee to determine
if the grant dates designated for share options or other shared-based payments in the entity's accounting
records corresponds to the actual date the appropriate committee met and approved the respective grants
 Review the amounts provided as compensation expense if it is measured at fair value and the amount
is reasonable.
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4. Analyze Retained Earnings and review appropriateness of Dividends
Retained Earnings represent the cumulative balance of periodic net income or loss, dividend distributions, prior
period errors, changes in accounting policy and other capital adjustments. The audit work of retained earnings and
dividends includes two major steps. These are:
 The review of retained earnings and any appropriation of retained earnings- the auditor should review the
changes in retained earnings during the year:
Transactions in retained earnings normally consist of net income or loss, dividends, appropriations in
retained earnings and quasi reorganizations, but they may also include adjustments to opening retained
earnings arising from changes in accounting policy and prior period error corrections. The only verification
necessary for these transactions is to ascertain that the dates and amounts correspond to the actions of the
board. Appropriation of retained earnings requires specific authorization by the board of directors. Audit
procedures performed when auditing Retained Earnings may include the following:
o Check the opening retained earnings if they include prior years adjusting journal entries. For
continuing auditor, opening balance of retained earnings may be verified from the prior year working
paper.
o Check for proper authorization by appropriate official or the board of directors for any movement in
retained earnings, including dividend declaration other than closing of net income or loss and any
prior period adjusting entries to retained earnings.
o Check the proprietary of entries related to transactions in retained earnings.
o Check for proper disclosure of retained earnings.
 The review of dividend procedures for both cash and stock dividends- in the verification of cash dividends,
the auditors usually, will perform the following steps:
o Determine the dates and amounts of dividends authorized
o Verify the amounts paid
o Determine the amount of any preferred dividend is arrears
o Review the treatment of unclaimed dividend checks.
The auditors’ analysis of divided declarations may reveal the existence of cash dividends declared but
not paid. These dividends must be shown as liabilities in the balances sheet. The auditors also may review
the procedures for handling unclaimed dividends and ascertain that these items are recognized as liabilities.
The amount of any accumulated divided in arrears on preferred stock should be computed. In the verification
of dividend there is additional responsibility of determining that the proper amounts have been transferred
from retained earnings to capital stock and paid-in-capital accounts for both large and small stock dividends.
When auditing dividends, the auditor should ensure whether the dividend has been:
o Properly declared in accordance with the requirements of the Corporation Code of the Philippines.
o Properly authorized in accordance with entity’s procedures.
o Properly accounted for, in accordance with the requirements of applicable PFRSs
o Complied with the requirements of applicable tax law and regulation.
5. Review Financial Statements Presentation and Disclosure of Shareholders’ Equity Items

The auditor should check at a minimum whether disclosures include the following information: title of each issue,
par or stated value, dividend rate, dividend on preference shares, conversion and call provisions, number of shares
authorized, issued and in treasury shares, dividend in arrears of cumulative preference shares and unissued shares
reserved for share options or for conversions
When reviewing the appropriateness of financial statement presentation of shareholders’ equity items, the
auditor needs to check that cost of treasury shares and subscription receivables should be shown as deduction in the
shareholders’ equity section.
AUDIT OF SOLE PROPRIETORSHIP, PARTNERSHIP AND OTHER TYPES OF ENTITY
Although most audits conducted are on corporations, smaller business may arrange for an independent
audit for some business purpose.
Procedures for Audit of Sole Proprietorships
When auditing the financial statements of a proprietorship, the auditor normally will not find formal documents
establishing the basis for changes in the capital assigned to the business. Under such circumstances, the auditor should
ensure that:
 Changes in the capital accounts are approved by the proprietor
 Personal transactions of the proprietor should not be included in that of the proprietorship in accordance
with the accounting entity assumptions, and
 The nature of the transactions is appropriately disclosed in the financial statements.
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Procedures for Audit of Partners’ Account
When auditing a partnership, the auditor should obtain a basic understanding of the provisions of the Civil
Code and of the partnership agreement, which is documented in the Articles of Partnership. Information in that
document which may be useful includes:
 The basis for sharing profits or loss if any;
 The basis for making drawings;
 The levels at which capital must be maintained;
 The basis for making loans to partners;
 The conditions of withdrawal from the partnership; and
 The conditions for making changes in the partnership agreement.
If a written agreement does not exist, the auditor may consider obtaining representation letter from the partners
to confirm their accounts to obtain satisfaction that the partnership has run its affairs in accordance with the
understanding among the partners.
Procedures for Audit of Other Types of Entity

When auditing a partnership, the auditor should obtain a basic understanding of the provisions of the Civil
Code and of the partnership agreement, which is documented in the Articles of Partnership. Information in that
document which may be useful includes:
SITUATIONAL PROBLEM NO. 1 – Umbrella Corp. .

You are a CPA engaged in the audit of Umbrella Corporation, whose records have not previously been audited
by her firm. The company has an independent stock transfer agent, as well as a registrar for its share capital. The
registrar maintains the record of shareholders showing the names and addresses of registered shareholders at
any time, while the transfer agent checks that there is no overissuance of shares and maintains the record of share
transfers. Both the transfer agent and registrar are required to validate share certificates.
Alice Abernathy, one of the senior auditors on the audit team proposes that confirmations be obtained from
both the independent registrar and stock transfer agent regarding the shares outstanding at the balance sheet
date. He then proposes that no additional work is to be performed on the share capital account if the confirmations
agree with the books. Do you agree or disagree that this will be sufficient? If yes, give justification for your position.
If no, state specifically the additional steps the auditors would take and why they would take them.
The proposal of Alice with regards to limiting work to the confirmations is not justified by the facts in the
scenario. Although, the number of shares issued and outstanding on the balance sheet date may be confirmed by
direct communication with the independent registrar and stock transfer agent, and is essential for ensuring the
accuracy and reliability of balances and details, the same can be used only for additional confirmation and
reference purposes. Furthermore, an audit of share capital includes more than just determining the number of
shares outstanding. For example, do authorizations exist for the issuance of shares? What assets were received
in payment of shares? How were the transactions recorded? Are there any subscription contracts? Confirmation
from the registrar and transfer agent could not help in determining these things and additional audit steps are
certainly needed in the audit of Umbrella Corporation.
Additional audit steps that might be taken in the audit of the share capital of Umbrella Corporation are:
1. Examine the articles of incorporation and bylaws for provisions relating to share capital to determine
the number of shares authorized and minutes of directors’ meetings to determine authorization for
appointments of the stock registrar and the transfer agent and also to determine authorization for the
issuance or reacquisition of shares.
2. Trace the consideration received for share capital into the records — to determine what consideration
has been received and how it has been recorded.
3. Examine, schedule and review entries for treasury shares — to determine the existence of treasury
shares as authorized and to determine that a proper record has been made.
4. Compare dividends with shares outstanding at dividend dates — to determine that dividends have been
properly paid and also to substantiate the shares outstanding.
5. Review subscription and option contracts, etc.— to determine the facts in regard to subscriptions and
options and to determine that these facts have been properly recorded and that they are adequately
disclosed.
6. Analyze the share capital accounts to obtain an orderly picture of share transactions for use as a guide
to other auditing procedures and as a permanent record.
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SITUATIONAL PROBLEM NO. 2 – Ciri Corp. .
A share option plan for its officers and key employees has been established this year by Ciri Corporation.
Because the options granted have a higher option price than the share’s current market price, Ciri Corporation has
not recognized any cost for the options in the financial statements. However, a note to the financial statements
includes all required disclosures.
a. Do you believe that management of Ciri Corporation has appropriately accounted for the share option plan?
Explain your answer.
b. List the audit procedures, if any, that you believe should be applied to the share option plan.
a. Despite the fact that the share options have a higher option price than the share’s current price, they may
well have value. Call options with option prices that are higher than the related stock prices are traded on
option markets every day. The valuation of the options should be done by a business valuation expert or
specialist to determine the appropriate amount of compensation cost to be recognized.
b. The following are the list of the audit procedures which should be applied to the share option plan:
 Obtain a copy of the share option plan for the auditor's permanent file and become thoroughly familiar
with its provisions.
 Trace the approval of the plan to minutes of directors' and shareholders' meetings.
 Prepare a working paper for the permanent file showing the number of shares authorized by the
plan, shares exercised, granted and expired each year.
 With reference to minutes of board of directors' meetings. Verify the number of shares granted and
the market price at date of grant by reference to financial publications.
 For proper valuation of the share options, management's specialist should be used, or if not
available, engage a specialist.
 Compute the number of options expired during the year and the number outstanding at the balance
sheet date.
 Assess the reasonableness of the estimated value of the options used to calculate compensation
cost. This would include assessing the qualifications and objectivity of the specialist. The auditors
should also obtain an understanding of the methods and assumptions used by the specialist, make
appropriate tests of data provided to the specialist, and evaluate whether the specialist’s findings
support the related assertions in the financial statements.
SITUATIONAL PROBLEM NO. 3 – Arkadia Corp. .

Octavia Blake, CPA is currently performing the audit of the shareholder's equity section of Arkadia
Corporation. She was asked to write a short memo about the internal control weaknesses she has identified and
the potential risk/s attached to each weakness. Arkadia Corp. is a public company and it has been a public
company since April of the current year, when it went through its initial public offering (IPO). Since the company is
growing, it has been implementing different controls with regards to keeping records of the company.
Lexa, the equity accountant, has been having a hard time learning all the new regulations, keeping the records
up to date, and ensuring that the dividend payments are made on time. Arkadia issued two classes of shares in its
IPO. "Class A" shares with 10 votes were issued to the Griffin family so they could retain control of the company
and "Class B" shares were issued to the general public with 1 vote each.
When Octavia reviewed the accounting records, she noticed that records contained only one account for share
capital. What should Octavia include in her memo with regards to internal control weaknesses which are evident
at Arkadia and what are their implications?
Internal control weaknesses at Arkania identified by Octavia include:
 Inappropriate segregation of duties: Lexa is in charge of keeping the records as well as disbursing dividends
to shareholders. These functions should be separated as this increases the risk of fraud and the possibility
that Lexa could create and conceal a fraud.
 Potential lack of knowledge from Lexa, the equity accountant:
- Arkadia is now a public company and it appears that Lexa does not have extended knowledge of
or experience with regards to regulations and laws governing the corporations. Noncompliance with laws
and regulations could result in penalties or fines for Arkadia. This increases the risk for Arkadia and also
means that the auditor will have to perform additional procedures and reviews.
- Lexa classified all the common shares in the same share capital account which will result in
improper presentation and note disclosure in the financial statements. This could be caused by the lack of
training or knowledge of Lexa or lack of management review of the work done by her. As a result, additional
procedures will have to be performed to ensure that proper disclosure is done.
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SITUATIONAL PROBLEM NO. 4 – Winterfell Corp. .
Arya Stark, CPA is engaged in an audit of financial statements of Winterfell Corporation. Winterfell employs
the services of a transfer agent to disburse dividends to the entity’s shareholders. Arya found a debit entry
amounting to $150,000 labeled as Dividends in the Retained Earnings.
a. If an independent transfer agent disburses dividends, explain how the audit of dividends declared and
paid is affected. What audit procedures are necessary to verify the existence of recorded dividends in RE
and the dividends paid by Winterfell?
b. Assuming Winterfell Corporation does not employ the services of an independent agent and maintain its
own dividend records, determine the necessary audit procedures in relation to the case above.
a. The existence of recorded dividends can be checked by examining the board of directors’ (BOD) minutes
of meetings for the amount of the dividend per share and the dividend date. From the minutes, the auditor
would determine the nature of the dividend, the amount per share, date of declaration, date of record,
and date of payment. When the auditor examines the board of directors' minutes for dividends declared,
the auditor should be alert to the possibility of unrecorded dividends declared, particularly shortly before
the balance sheet date. The accuracy of a dividend declaration can be audited by re-calculating the total
amount on the basis of the dividend per share and the number of shares outstanding. Since Winterfell
uses a transfer agent to disburse dividends to its shareholders, the auditor should trace the amount to a
cash disbursement entry to the agent and verify the amount.
b. If Winterfell Corporation keeps its own dividend records and pays the dividend by itself, verification of the
total amount of the dividend can be done by the auditor by recalculation and reference to cash disbursed.
In addition to this, it is necessary to verify whether the payment was made to the shareholders who owned
the shares at the dividend record date. The auditor can test this by selecting a sample of recorded dividend
payments and tracing the payee's name on the cancelled cheque to the dividend records to ensure the
payee was entitled to the dividend. At the same time, the amount and the authenticity of the dividend
cheque can be verified.
Additionally, tests of dividends payable should be done in conjunction with declared dividends. If the
payment date occurs after the balance sheet date, the auditors should ascertain that any cash dividend
payable or unpaid dividend is included among the current liabilities and that adequate disclosure is made
for any share dividend.
SITUATIONAL PROBLEM NO. 5 – Arthdal Corp. .

Tanya, CPA is engaged in an audit of Arthdal Corporation, whose records have been previously audited by
her firm. In her second annual audit, Tanya finds a new account in the general ledger called Treasury Share, which
has a balance of $123,000 and which was not encountered by the auditors during the first audit of the corporate
client. Describe the procedures the auditors would follow to verify this account.
Since the Treasury Share account was not encountered by the auditors during their first audit of the corporate
client, the auditors may assume that the company acquired treasury shares during the year by purchase, donation
from shareholders, in exchange for cancellation of a receivable, or some similar manner. To determine just how
these shares were acquired and whether they are properly stated at the amount of $123,000, the auditors should
begin by analyzing the Treasury Share account. The treasury share certificates should be inspected and tied in
with the account analysis. In verifying the entries to the account, the auditors should refer to the board of directors'
(BOD) minutes of meetings to determine whether the reacquisition or reissuance was authorized by the BOD. The
auditors should also verify whether the price paid or received was in accordance with price specified by the BOD.
For non-cash consideration, the auditors should determine whether it was properly accounted for under applicable
PFRs or not. Finally, the auditors should determine the legal restriction on retained earnings in the acquisition of
treasury shares.
PRACTICAL PROBLEMS
PRACTICAL PROBLEMS NO.1 – MONTE COMPANY

Monte Company was organized on January 2, 2019, with authorized share capital of 50,000 shares of 10%, 200 par
value preference and 200,000 shares of P10 par value ordinary.
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During the company’s first two years of operations, the following equity transactions occurred:
2019
JAN. 2 Sold 10,000 ordinary shares at P16.
2 Sold 3,000 preference shares at P216.
MAR. 2 Sold ordinary shares as follows: 10,800 shares at P22; 2,700 shares at P25.
JULY 10 Acquired a nearby piece of land, appraised at P400,000, for 600 preference shares and
27,000 ordinary shares. (Preference share capital was recorded at P216, the balance
being assigned to ordinary.)
DEC 16 Declared the regular preference share dividend and a P1.50 ordinary share dividend.
28 Paid the dividends declared on December 16.
31 The income summary account showed a credit balance of P450,000.
2020
FEB 27 Reacquired 12,000 ordinary shares at P19.
JUNE 17 Resold 10,000 treasury shares at P23.
JULY 31 Resold all of the remaining treasury shares at P18.
SEP. 30 Sold 11,000 additional ordinary shares at P21.
DEC. 16 Declared the regular preference share dividend and an P0.80 ordinary share dividend.
28 Paid the dividends declared on December 16.
31 The income summary account showed a credit balance of P425,000.
FEB 27 Reacquired 12,000 ordinary shares at P19.
Questions:
Based on the above information, determine the balances of the following:
1. Preference Share Capital
2. Ordinary Share Capital
3. Total Share premium
4. Unappropriated Retained earnings
5. Total Shareholders’ equity
1. Preference share capital (3,000 + 600 = 3600 x P20) = P720,000
(10,000 + 13,500 + 27,000 + 11,000 = 61,500 x P10) =

2. Ordinary share capital P615,000
3. 1/2/19 (P6 x 10,000) 60,000

(P16 x 3,000) 48,000
3/2/19 (P12 x 10,800) + (P15x 2,700) 170,100
7/10/19 (P16x600) + P400 10,000
6/17/20 (P230,000-P190,000) 40,000
9/30/20 (P11x11,000) 121,000
Total Share premium 449100
4. Net Income -2019 P450,000

Dividends -2019 -147,750
Net Income -2020 425,000
Dividends -2020 -121,200
Retained Earnings, 12/31/20 P606,050
5. Preference share capital P720,000

Ordinary share capital 615,000
Share Premium 447,100
Retained earnings 606,050
Total shareholders’ equity P2,388,150
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PRACTICAL PROBLEMS NO. 2 - TANYA COMPANY
You have been asked to audit the Tanya Company. During the course of your audit, you are asked to prepare
comparative data from the company's inception to the present. You have determined the following:
a. Tanya Company’s charter became effective on January 2, 2008, when 20,000 shares of P10 ordinary shares
and 10,000 shares of 7% cumulative, nonparticipating preference shares were issued. The ordinary shares were
sold at P12 per share, and the preference shares were sold at par value of P100 per share.
b. Tanya was unable to pay preference dividends at the end of its first year. The owners of the preference shares
agreed to accept 2 ordinary shares for every 50 preference shares owned in discharge of the preference dividend
due on December 31, 2008. The shares were issued on January 2, 2009. The fair market value was P30 per
share for ordinary shares on the date of issue.
c. Tanya Company acquired all the outstanding shares of Akinka Corporation on May 1, 2010, in exchange for
10,000 ordinary shares of Tanya.
d. Tanya split its ordinary shares 3 for 2 on January 1, 2011 and 2 for 1 on January 1, 2012.
e. Tanya offered to convert 20% of the preference shares to ordinary shares on the basis of 2 ordinary shares for
1 preference share. The offer was accepted, and the conversion was made on July 1, 2012.
f. No cash dividends were declared on ordinary shares until December 31, 2010. Cash dividends per share of
ordinary shares were declared and paid as follows:
June 30 Dec 31
2010 - P3.20
2011 P1.50 P2.50
2012 P1.25 P1.00
Questions:
Based on the preceding information, determine the following:
1. The number of ordinary and preference shares outstanding on December 31 of each of the following years:
a. 2010
b. 2011
c. 2012
2. The amount of cash dividends declared and paid to shareholders for each of the following years:
a. 2011
b. 2012
SHARES OUTSTANDING
Ordinary Preference
JAN. 2, 2008 20,000 10,000
Ordinary shares issued to preference
JAN. 2, 2009 400
shareholders (10,000/50 x 2)
DEC. 31, 2009 20,400 10,000
MAY 1,2010 Acquisition of Akinka Corp. 10,000 -
DEC. 31, 2010 1.a. 30400 10,000
#1
JAN. 1, 2011 Stock split- 3:2 (30,400/2x3) -330,400 15,200
DEC. 31, 2011 1.b. 45600 10,000
JAN. 1, 2012 Stock split- 2:1 45,600 -
Conversion of preference shares (10,000
JULY 1, 2012 4,000 (2,000)
x 20% = 2,000 x 2 = 4,000)
DEC 31, 2012 1.c. 95,200 8,000
2.a. (P4 x 45,600) = P182,400 - Dividend declared and paid 2011

#2
2. b. (P1.25 x 91,200) + (P1 x 95,200) = P209,200 paid and declared 2012
PRACTICAL PROBLEMS NO. 3 – BLUE COMPANY

At the beginning of year 1, Blue Company grants to a senior executive 30,000 share options. The grant is conditional
upon the executive remaining in the entity’s employ until the end of year 3.
The share options can be exercised if the entity’s share price increases from P20 at the beginning of year 1 to above
P30 at the end of year 3. I f the share price is above P30 at the end of year 3, the share options can be exercised at
any time during the next five years, i.e., by the end of year 8.
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The entity estimates the fair value of the share options on grant date to be P5 per option. This estimate takes into
account the following market condition:
 The possibility that the share price will exceed P30 at the end of year 3, i.e., the share options become
exercisable; and
 The possibility that the share price will not exceed P30 at the end of year 3, i.e., the share options will be
forfeited.
The following actual events occurred in years 1 to 3:
Year 1
 The share price has increased to P24.
 The entity’s estimate of the fair value of the options is P4 at the end of year 1. This takes into account
whether the market condition will be satisfied by the end of year 3.
Year 2
 The share price has decreased to P22. However, the entity remains optimistic that the share price
target will be met by the end of year 3.
 The estimated fair value of the share option is P3. Again, this estimate takes into account the market
condition noted above.
Year 3
 The share price only reaches P28 by the end of year 3.
 The estimated fair value of the share options is zero, as the market condition has not been satisfied.
Questions:
Based on the preceding information, determine the following:
1. Compensation expense for year 1
4. Share options outstanding at the end of year 2
5. Cumulative compensation expense for the three-year period.
COMPENSATION CUMULATIVE
YEAR CALCULATION EXPENSE FOR THE COMPENSATION
PERIOD EXPENSE
1 30,000 options x P5 fair value x P50,000 P50000
1/3
2 30,000 options x P5 fair value x 50,000 100,000
1/3
3 30,000 options x P5 fair value x 50,000 150,000
1/3
PRACTICAL PROBLEMS NO. 4 – FORGE INC.

The following information has been taken from the Accumulated profits ledger accounts of FORGE INC.
a. Total net income since incorporation P2,550,000

b. Total cash dividends paid 150,000
c. Carrying value of company's equipment declared as property dividend 600,000
d. Proceeds from sale of donated stocks 150,500
e. Total value of stock dividends distributed 640,000
f. Gain on treasury share transaction 375,000
g. Unamortized premium on bonds payable 413,200
h. Appropriated for plant expansion 700,000
i. Loss on treasury share reissue 415,000
j. Share premium in excess of par from issued shares 215,000
k. Share issuance expense 45,000
l. Appropriated for remaining treasury shares at cost P25/share 200,000
Additional notes:
 The equipment declared as dividends had a recoverable value/ fair market value of P450,000 as of the date
of declaration and P440,000 on the date of settlement.
 The stock dividends distributed was based on a 20% share dividend declared on 100,000, P25 par value
outstanding shares. The market value of shares on the date of declaration was at P32 per share.
 The only transactions affecting the treasury shares were those described in item f. and i.
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Questions:
1. How much should be the correct debit to retained earnings for the property dividends upon declaration?
2. How much should be recognized in the profit/loss from the settlement of the property dividends.
3. How much should be the correct debit to retained earnings for the share dividends?
4. How much is the correct balance of the Accumulated retained earnings unappropriated account?
5. The necessary adjustment involves an adjustment to additional paid-in capital in the amount of:
1. Entries upon declaration of property dividends:
Property dividends 450,000
Non-current asset held for disposal 450,000

Loss 150,000
Equipment 600,000
2.Entries upon settlement of property dividends:

Property Dividends payable 10,000
Property Dividends payable 440,000

Loss 10,000
Non-current asset held for disposal 450,000
3. Shares outstanding 100,000

Multiply by 20%
Dividends distributable, small 20,000
Multiply by fair value 25
Appropriation for share dividends 500,000
4. Accumulated retained earnings unappropriated

account
a. Total net income since incorporation P2,550,000
b. Total cash dividends paid -150,000
c. Impairment of property declared as dividend -150,000
Appropriation for property dividend at final fmv -440,000
c. Loss on settlement of property dividend -110,000
payable
e. Correct valuation of share dividends -500,000
h. Appropriated for plant expansion 700,000
i. Loss on treasury share reissue 415,000
l. Appropriated for remaining treasury shares at 200,000 l. Appropriated for remaining treasury
cost P25/share shares at cost P25/share
Correct Unappropriated Accumulated profits 360,000 Correct Unappropriated Accumulated
balance profits balance
5. Necessary adjustment involves an adjustment 5.

to additional paid-in capital
150,500 d. Proceeds from sale of donated
d. Proceeds from sale of donated stocks
stocks
f. Gain on treasury share transaction 375,000 f. Gain on treasury share transaction
i. Loss on treasury share reissue -375,000 i. Loss on treasury share reissue
j. Share premium in excess of par from issued 215,000 j. Share premium in excess of par from
shares issued shares
k. Share Issuance expense -45,000 k. Share Issuance expense
APIC 320,500 APIC
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PRACTICAL PROBLEMS NO. 5 - BANGLADDESH COMPANY
Bangladdesh Company’s December 31, 2018, audited statement of financial position reported retained earnings of
P150,000. Net income for 2018 was P85,000 and dividends of 60,000 were declared and paid in 2018. Bangladesh’s
accountant discovered that net income for 2017 had been understated by 25,000 due to an error in recording
depreciation expense for 2017.
Question:
1.) What is the amount of retained earnings per books as of December 31, 2017?
Suggested Solution:
Retained earnings per books, Dec. 31, 2017 (SQUEEZE) 100,000
Adjustment for depreciation error in 2017 25,000
Retained earnings as adjusted, Dec 31, 2017 125,000
Net Income for 2018 85,000
Dividends declared and paid in 2018 -60,000
Retained earnings per audit, Dec. 31,2018 150,000
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OUTLINE
1. Correction of Error
1.1 Error Correction and Accounting Changes in GAAP
1.2 Errors in Auditing
1.3 Error as distinguished from Fraud
1.4 Responsibilities of Auditor
1.5 Primary Audit procedures in Detecting Errors
1.6 Alternative Procedures
2. Cash and Accrual

2.1 Revenue recognition
2.2 Matching principle
2.3 Cash basis accounting
2.4 Accrual basis accounting
2.5 Comparison of cash basis and accrual basis accounting
3. Single Entry
3.1 Introduction to single entry system in accounting
3.2 Single entry vs. Double entry accounting
3.3 Double entry system: Built in Error Checking
3.4 Single Entry system: Error checking is not built in
3.5 Double entry system: Focus on revenue, expenses, assets, liabilities and Equities
3.6 Single entry system: Focus on revenues and expenses
3.7 Single entry system do not support accrual accounting
4.1 Situational Problem no.1- A Ltd.
4.2 Situational Problem no.2- Error and Fraud
4.3 Situational Problem no.3- Compo. Corp.
4.4 Situational Problem no.4- Booking the Budget
4.5 Situational Problem no.5-
5.1 Practical Problem no.1- Ganesh Business
5.2 Practical Problem no.2- Asha And Ushu Partnership
5.3 Practical Problem no.3- Blue Corp.
5.4 Practical Problem no.4- Adjusted Net income/Loss and RE
5.5 Practical Problem no.5- Franzine Gomez Co.
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ERROR CORRECTION
Error Correction and Accounting Changes in GAAP
An error correction is the correction of an error in previously issued financial statements. This can be an error
in the recognition, measurement, presentation or disclosure in financial statements that are caused by:
 Mathematical mistakes
 Mistakes in applying GAAP
 Oversight of facts existing
 Misuse of facts
 Incorrect classification of expense as an asset or vice versa
 Changes in estimates which are not prepared in good faith
 A change in accounting principle that is not generally accepted to GAAP.
An accounting change can be a change in accounting principle, an accounting estimate or the reporting entity.
Simply stated, the correction of error is not an accounting change. However, the reporting of an error correction involves
adjustments to previously issues financial statements similar to those generally applicable to reporting an accounting
change retrospectively.
 Types of Error
o Balance sheet errors
This type of error refers to improper classification of real accounts. No effect in Net income.
o Income statement errors
This type affects only presentation of nominal accounts in the income statement. It involves the
improper classification of revenues and expenses accounts hence only details of income statements
are misstated. A reclassifying entry is necessary only if the error is discovered in the yea it is
committed. It has no effect on the balance sheet and in the income statement if the error is discovered
in subsequent year.
o Combined Balance sheet and Income statement error
Affects both balance sheet and income statement, this results in the misstatement of net income.
 Classification of Combined Error
o Counter balancing error
Errors which if not detected are automatically corrected in the next accounting period. i.e. these
errors will correct themselves over two periods. Restatement is necessary even if a correcting journal
entry is not required.
Includes the misstatements of the following accounts:
o Inventories (including purchases and sales)
o Prepaid expenses
o Deferred income
o Accrued expense
o Accrued income
Guidelines if Books are open
o If the error is already counterbalanced and the company is in the second year, an entry
is necessary to correct the current period and to adjust the beginning balance of retained
earnings.
o If the error is not yet counterbalanced, an entry is necessary to adjust the beginning
balance of retained earnings and correct the current period.
Guidelines if Books are closed
o If the error is already counterbalanced, no entry is necessary.
o If the error is not yet counterbalance, an entry is necessary to adjust the present balance
of the retained earnings.
o Non counter balancing errors
Errors which takes longer than two periods to correct themselves. This type of error is carried
over to the subsequent accounting period until corrected or until the balance sheet item involved is
removed from the accounts by sales, retirement or other means of disposal.
Errors in auditing
Errors are unintentional misstatements as previously discussed, including an omission of an amount or a
disclosure.
When an auditor finds misstatements as he performs an audit, he is responsible for making an assessment,
he must determine whether the misstatements represent an error or a fraud.
Common errors encountered during audit
o Inadvertently taking an expense to the wrong account
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Example:
an advertising expense shows up as an amortization expense.
o Booking an unreasonable accounting estimate for allowance for bad debt expense
Example:
the person who made such mistake may have misinterpreted facts, or most often than not just
another clerical error.
o Incorrectly applying accounting principles
Example:
Recording assets at their cost rather than their market values is an example of an accounting
principle. Make sure the company hasn’t inadvertently made an adjustment to increase the
value of the asset (such as land or building) to their appraised value rather than cost. It’s
never appropriate to change the value of a fixed asset on the balance sheet from its original
cost.
Error as distinguished from Fraud
Fraud occurs when someone purposefully produces deceptive data. As opposed to error, fraud is intentional.
Fraud can take the form of falsification or alteration of accounting records or the financial statements. It also includes
intentional omission of significant information.
Responsibility of the auditor
The auditor is not and cannot be held responsible for the prevention of fraud and error. The auditor’s
responsibility is to design the audit to obtain reasonable assurance that the financial statements are free from material
misstatements, whether caused by error or fraud.
Consequently, the auditor should make:
1. Inquiries of management
The auditor should inquire about the possibility of misstatements due to fraud and error such includes:
o Management assessment of risk
o Controls established to address the risk
o Any material error or fraud that has affected the entity or suspected fraud that is being
investigated
o whether accounting principles are being followed while preparing books of accounts
o If policies of management are being followed or not
o Whether provisions laid in the company act are being followed while preparing book of accounts
o Whether balance sheet Profit and loss account show true and fair.
2. Assess the risk that fraud or error may cause the financial statements to contain material misstatements.
PSA 240 requires the auditor to specifically “assess the risk of material misstatement due to fraud
and consider that assessment in designing the audit procedures to be performed”. Judgement about the
increased risk of material misstatement due to fraud may influence the auditor’s professional judgement
such as having a heightened level of professional skepticism.
3. During the course of the audit, the auditor may encounter circumstances that may indicate the possibility
of fraud or error such as discrepancies found in the accounting records and conflicting or missing
documents. In these circumstances, the auditor should perform procedures necessary to determine
whether material misstatements exist.
Primary audit procedures in Detecting Errors
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 Test of details of transactions allows the auditor to assess how transactions are recorded, by means
of analyzing credit or debit accounts.
 Test of details of balances are aimed to collect rather evidence of accounts balances, than of
individual transactions that led to those balances. The auditor checks the total amount of debt to a
supplier, by requesting a written confirmation from the supplier, and not by checking the final balance
of the respective supplier account.
 Analytical procedures are those procedures that analyze various accounting correlations in order to
identify the trends of the analyzed elements.
Alternative Procedures
 An inspection consists in examining records, documents, or tangible assets.
 Observation consists in pursuing a process or a procedure performed by other persons, such as,
for example, observation by the auditor of stocktaking performed by the company’s personnel or
observation of control procedures application that do not generate audit evidence.
 Examination of documents and records received or issued by the audited company presumes
reading of documents, tracking their circuit, their comparison and reconciliation. The auditor may
examine minutes of the Board of Directors in order to understand the policies implemented by the
audited company regarding funding. Also, by tracking the circuit of documents, the auditor checks
how invoices issued to clients or those received from suppliers are recorded in accounting.
 Investigation consists in obtaining information by addressing written or oral questions to people
inside or outside the company that can provide to the auditor information that he could not obtain by
applying of control tests and procedures. Investigations and procedures for obtaining audit evidence
are more effective when combined with confirmations, usually requested from third parties.
 The calculation consists in checking the arithmetic accuracy of amounts included in source
documents, accounting records or financial statement.
o Audit procedures that are effective for detecting material errors may be ineffective for detecting
material fraud. This is due to the fact that fraud may involve sophisticated and carefully organized
schemes designed to conceal it.
4. After identifying material misstatement in the financial statements, the auditor should consider whether
such a misstatement resulted from a fraud or an error. Errors will only result to an adjustment of financial
statements, but fraud may have other implications on an audit.
5. When the auditor believes that material error or fraud exists, he should request the management to revise
the financial statements. Otherwise, the auditor will express qualified or adverse opinion.
CASH AND ACCRUAL BASIS
Revenue Recognition
Revenue is not difficult to define or measure; it is the inflow of assets from the sale of goods and services to
customers, measured by the cash expected to be received from customers. However, the crucial question for the
accountant is when to record a revenue. Under the revenue recognition principle, revenues should be earned and
realized before they are recognized (recorded).
Matching Principle
Expense recognition is closely related to, and sometimes discussed as part of, the revenue recognition
principle. The matching principle states that expenses should be recognized (recorded) as they are incurred to produce
revenues. An expense is the outflow or using up of assets in the generation of revenue.
Cash Basis Accounting

Cash (or cash-basis) accounting recognizes the effects of accounting events when cash is exchanged
regardless of the time events occur. Cash-basis accounting is not in accordance with generally accepted accounting
principles (GAAP).
The cash basis of accounting recognizes revenues when cash is received and recognizes expenses when
cash is paid out. For example, a company could perform work in one year and not receive payment until the following
year. Under the cash basis, the revenue would not be reported in the year the work was done but in the following year
when the cash is actually received. Because the cash basis of accounting does not match expenses incurred and
revenues earned in the appropriate year, it does not follow Generally Accepted Accounting Principles (GAAP). The
cash basis is acceptable in practice only under those circumstances when it approximates the results that a company
could obtain under the accrual basis of accounting. Companies using the cash basis do not have to prepare any
adjusting entries unless they discover they have made a mistake in preparing an entry during the accounting period.
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Accrual Basis Accounting
Accrual (or accrual-based) accounting recognizes the effects of accounting events when such events occur
regardless of the time cash is exchanged.
Most companies use the accrual basis of accounting. The accrual basis of accounting recognizes revenues
when earned (a product is sold or a service has been performed), regardless of when cash is received. Expenses are
recognized as incurred, whether or not cash has been paid out. For instance, assume a company performs services
for a customer on account. Although the company has received no cash, the revenue is recorded at the time the
company performs the service. Later, when the company receives the cash, no revenue is recorded because the
company has already recorded the revenue. Under the accrual basis, adjusting entries are needed to bring the accounts
up to date for unrecorded economic activity that has taken place.
Comparison of Cash Basis and Accrual Basis Accounting
Items of comparison Cash Basis Accrual Basis
Sales Includes: Includes:
-Cash sales -Cash sales
-Collection of trade accounts -Credit sales (sales on account)
receivable
-Collection of trade notes receivable
Income other than sales Includes only those collected during Includes those items earned during
the period the period
Purchases Includes the following : Includes the following :
-Cash purchases -Cash purchases
-Payment of trade accounts payable -Purchase on account
-Payment of trade notes payable
-Payment in advance to suppliers
Expenses, in general Includes only those expenses that Includes only those items that are
are paid incurred regardless of when paid
Deprecation Depreciation is typically provided Depreciation is typically provided.
except when the cost of equipment
was treated as expense
Bad debts No bad debts expense is recognized Doubtful accounts are treated as bad
since cash basis does not recognize debts.
receivables. Although some problem
may give an indication that the
accounts written off were charged to
bad debts expense.
SINGLE ENTRY
(Accounts from Incomplete Records)
Introduction to Single Entry System in Accounting

When you start a small business, one of your first financial decisions has to be whether you are going to use
single or double-entry bookkeeping. As your small business begins to make transactions, you need to record them in
your books. Businesses have to keep a detailed accounting of their financial transactions. This process is known as
bookkeeping. The survival of the business depends on the owner’s ability to establish good accounting practices.
In small businesses, there is a major problem that due to shortage of time and experience, these cannot
maintain full accounting records under double-entry system. Furthermore, these cannot afford to hire outside staff to
keep such record. But every business needs to know about its trading result after specific intervals. So we can say that
any set of procedures which ascertain the profit or loss of a business and does not maintain its record under double
entry system is generally referred as “Single Entry System”.
A single entry system records each accounting transaction with a single entry to the accounting records, rather
than the vastly more widespread double entry system. The single entry system is centered on the results of a business
that are reported in the income statement. The core information tracked in a single entry system is cash disbursements
and cash receipts. The primary form of record keeping in a single entry system is the cash book.
In a nut shell it can be concluded that single entry is a system in which accounting records are not recorded
exactly like Double Entry System. As the records are not kept under double entry system, we can say that these are
incomplete records and therefore trial balance cannot be prepared. This can result in frauds and misappropriation.
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Single-Entry vs. Double-Entry Accounting
The single-entry approach contrasts with double-entry accounting, in which every financial event brings at
least two equal and offsetting entries. One is a debit (DR) and the other a credit (CR). As a result:
 Firms using the double-entry approach report financial results with an accrual reporting system
 Firms using single-entry approach are effectively limited to reporting on a cash basis.
Double-Entry System: Built-in Error Checking
A double-entry system provides several forms of error checking that are absent in a single-entry system. In
the double-entry system, every financial transaction results in both a debit (DR) in one account and an equal, offsetting
credit (CR) in another account. For each reporting period, total debits must equal total credits. That is Total DR = Total
CR. Moreover, a single-entry system works so that the Balance sheet equation always holds: Assets = Liabilities +
Equities. These equations together are known as the accounting equation. Any departure from these principles in a
double-entry system is a signal that account histories include an error.
Single-Entry System: Error Checking Is Not Built In
This kind of error checking is missing from the single-entry system. If the single-entry bookkeeper mistakenly
enters, say, a revenue inflow as $10,000 when the correct value is $1,000, the error may go unnoticed until the firm
receives a bank statement with an unexpected low account balance.
In a double-entry system, however, the $1,000 cash deposit entry (a debit to an asset account, cash on hand)
will be accompanied by another entry recognizing the source, for example, a credit to a liability account (e.g., bank
loan) or a credit to another asset account (accounts receivable). And, if the firm omits the second entry, the sums of
credits and debits in the system would differ, immediately revealing the error.
Double-Entry System: Focus on Revenues, Expenses, Assets, Liabilities, and Equities.
A double-entry system keeps the firm's entire "Chart of accounts" in view. This chart for a double-entry system
has, in fact, five kinds of accounts in two categories:
 Firstly, Income statement accounts: (1) Revenue accounts, and (2) expense accounts.
 Secondly, Balance sheet accounts: (3) Asset accounts, (4) Liability accounts and (5) Equity accounts.
All transactions in a double-entry system result in entries in at least two different accounts. When the company
receives cash through a bank loan, the double-entry system records:
 Firstly, a debit (DR) for an asset account, e.g., Cash on hand. For an asset account, a DR is an
increase.
 Secondly, a credit (CR) to a liability account, e.g., bank loans. A CR to a liability account increases its
balance.
Single-Entry System: Focus on Revenues and Expenses Only
A single-entry system tracks Revenues and Expenses but does not monitor Assets, Liabilities, or Owners
Equities. With a single-entry system, however, the company may receive cash from a bank loan and record that as
incoming cash. In this case, however, there is no easy way to register the corresponding increase in liability (bank
loan debt).
Single-Entry Systems Do Not Support Accrual Accounting
Single-entry systems, moreover, work hand-in-glove with cash basis accounting, where firms record inflows
and outflows only when cash, in fact, flows. Also, single-entry systems cannot easily support the alternative, accrual
accounting. When the delivery of goods and services and customer payments come at different times, for instance,
accrual accounting provides mechanisms for implementing the matching concept. Consequently, the firm recognizes
revenues and the expenses that brought them in the same accounting period.
If the vendor delivery and the customer payment fall in different time periods, however, the single-entry
system has no way of matching the two events. The single-entry system, therefore, can present a misleading picture
of earnings for either period.
The most significant problems associated with a single entry system include:
 Insufficient data to generate proper financial statements. You cannot generate financial
statements from data entered via a single entry system. Single entry system records only transactions
that the firm is undertaking with external parties. There are numerous transactions within the firm that
are of vital importance and need a place in the financial statements. However, the single entry system
ignores these needs and gives incomplete information to the management. This is why a single entry
system will not work or even be considered by larger companies.
 Audited financial statements. It is impossible to obtain an audit opinion on the financial results of a
business using a single entry system; the information must be converted to a double entry format for an
audit to even be a possibility.
 Errors. Mistakes are much more likely because the system does not need to self-balance. It is much
easier to make clerical errors in a single entry system, as opposed to the double entry system, where
separate entries to different accounts must match. This means some mistakes in recording a transaction
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may take a long time to find, or are never discovered. An audit would have to be done manually, line by
line.
 Reporting. There is much less information available upon which to construct the financial position of a
business, so management may not be fully aware of the performance of the business.
 Tax problems. A single entry system may help in general with bookkeeping, but it is not acceptable to
tax authorities due to the incomplete nature of the data recorded.
 No Reconciliation. Single entry accounting system does not have provisions for reconciliation of
accounts. This means that the system does not have inbuilt error detection. Therefore, if a clerk is doing
the task of making entries in the book, the system may be prone to clerical errors. This could lead to
management having insufficient information or no information when they have to make decisions.
 Possibility of Fraud. Single entry accounting system is highly prone to frauds and embezzlement. There
is only one book of account rather than an elaborate accounting system. Hence, the internal checks are
few. In fact, they are non-existent. The person making the accounts could single handedly manipulate
the books of accounts and misappropriate the resources of the firm.
 Theft. Criminal activity is less likely to be detected (this is because assets are not tracked). Thereby the
chance of the asset being stolen is probable.
Single entry systems are strictly used for manual accounting systems, since all computerized systems utilize
the double entry system instead. The size of the business and the amount of income and expenses that it incurs will
really help it determine whether a single entry system is appropriate or whether something more detailed is needed.
SITUATIONAL PROBLEM NO. 1- A Ltd.

You are a recently appointed audit partner in a large independent firm of accountants. You are delighted that
you are now a partner and can’t wait to sign off your first set of accounts. Your firm recently won an audit tender
for a medium-sized family owned company, A Ltd, and the firm’s managing partner has allocated the client to you.
The managing partner is reasonably close to the family which owns A Ltd and you believe that this is at least part
of the reason why the company decided to appoint your firm.
As is normal, you go through all the firm’s new client procedures which include writing to the previous auditors
and also obtaining sets of statutory accounts for the previous 3 years. When you receive the written reply from the
previous auditors, you note that they have nothing to report other than any matters addressed in their audit report.
This seems strange, so you quickly review the company’s set of financial statements for the previous year and
note that the company’s audit report was qualified on the basis of non-compliance with an accounting standard.
The audit report highlights that the company owns a property and advises that the directors, on cost grounds,
decided not to have an FRS 16 valuation performed. The audit opinion adds that the auditor is unable to quantify
the impact of this non-compliance with FRS 16. You wish that you had access to the working papers of the
predecessor auditors but the relevant audit regulation was not applicable at this time. What do you do now?
Discussion of the case:
Based on the information above, the first option is to try and persuade A Ltd. of the need to obtain an FRS 16
Valuation. The benefits of having a clean audit opinion should be conveyed to the director to help them arrive at a
more informed judgement as to whether the company should or should not obtain a valuation. It may be possible
to obtain sufficient other information to allow an assessment to the property in the audit opinion, which although
not removing the need for a qualified audit report woud possibly remove the need for a disclaimer of opinion.
SITUATIONAL PROBLEM NO. 2- Error or Fraud

An internal auditor selects from the multitude of services payments a transaction that pays for cleaning rolls
at the company’s headquarters. The company that cleaned them offers a discount of 2% if the invoice is paid within
10 days, what has happened. In terms of the quality, helped by another employee, the auditor concludes that the
rolls have been cleaned properly. By examining the document for providing the work, the purchase order, the
reception document and the invoice, the auditor considers that the transaction does not contain element of fraud.
By further examining the actual contract, the auditor finds that there has been negotiated discount of 10%
compared to the last minimum price published by the services provider. However, the invoice is issued for the full
price. Will this be classified as a mistake or a fraud?
This error of omitting to apply the discount was used in a repetitive manner, which shows that this is not a
simple mistake but fraud.
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SITUATIONAL PROBLEM NO.3 – Compo Corp.
Kelsey, a senior accountant at a multi-office CPA firm, is assigned to the audit of Compo Corporation. Compo
is a closely held corporation and a major client of the firm. During the audit, Kelsey finds a material cutoff error
which causes Compo’s income to be significantly misstated. Kelsey is aware that the CPA firm’s policy clearly
states the audit senior must document any potential material adjustment in the work papers. The final determination
of materiality is then made by the partner in charge of the audit. Kelsey also knows Compo does not want to make
the adjustment. Before wrapping up the field work, the audit manager, Bruce, tells Kelsey, “Let’s not mention this
adjustment in the work papers. Since Compo is closely held and there are not tax implications, the partner has
decided not to force an adjustment. Compo is our largest client. We need to get the Compo work up to the partner
as soon as possible.” Kelsey is concerned and upset after the conversation with Bruce. Failure to document such
a material amount just does not seem right.
Kelsey has a professional responsibility to document proposed material audit adjustments. She should
document the cutoff error because this is in compliance with the firm policy.
SITUATIONAL PROBLEM NO.4 - Booking the Budget

Maria and Andy worked well together to organize the accounting system and records of a growing Health
Maintenance Organization (HMO). Bob and Connie, the two top executives in the HMO, were tightly focused on
company growth as it related to monthly and yearly revenue. Bob was also in charge of budget reports.
Every month Maria and Andy would compile financial statements which were reviewed by company officers
and later reported in patient and employee newsletters. Oftentimes sales would fall below Bob’s original
projections. At such times, Bob would rant and rave about the low patient revenue accruals and comment “that
surely more must be accrued.” Andy and Maria would often remark to each other “why don’t we just book the
budget,” since that is essentially what they did every month after their initial financial figures were reviewed, at
least in terms of sales.
Although Andy and Maria realized that at year-end the auditors would not condone Bob’s recording practices,
they were still somewhat angry that “their” precise accounting system required monthly adjustments because of
Bob and Connie’s need to “look good to the board.” Of course, when year-end came, the glowing financial news
fell short of projections. Although the shortfall was not enough to raise the HMO rates, it did send a panic through
the accounting department. This information was not reported directly to shareholders, but it was embarrassing to
make the year-end adjustments while scrambling to uncover additional revenues; and explain to coworkers why
monthly newsletters were incorrect.
Possible alternatives are Maria and Andy can start a process to develop a formal mechanism, i.e., an ethics
committee, to consider ethical issues within the firm. Maria and Andy can ascertain whether Connie and the Board
are completely aware of the practice. Or Maria and Andy can inform Bob of their dissatisfaction.
SITUATIONAL PROBLEM NO.5 – Chris

Chris, a CPA and formerly a staff accountant for a large public accounting firm, is the new controller for a small
construction company that employs 60 people. The company is now facing tough times in light of a downturn in
the construction industry. Both Chris and the CEO, Robin, know the collectability of a material receivable from
Ender Corporation is in doubt. Just before year-end, Chris goes in to talk to Robin. Chris says, “Ender has real
problems. The word on the street is they won’t last the year. We need to adjust the allowance for the Ender
receivable.” Robin replies, “If we do that, we're not going to look good, and the auditor may have to mention our
shaky financial position. If we don’t get a clean opinion, we won’t get the bank loan we’re applying for, and we
might be out of business, too, by this time next year. This loan is really important to us. If we can just weather this
downturn, I know business will pick up.” Back in the controller’s office, Chris ponders what can be done to help
Robin and the company. Chris remembers the past years working in public accounting and is certain the auditor
would want to know about Ender’s difficulties. What possible alternative should Chris do?
Chris can Not snake the allowance adjustment and hope that the auditor will not ask about the likelihood of
Ender’s payment or be prepared to minimize Ender’s difficulties. Or he could Make the allowance adjustment for
the total expected uncollectable and/or be straightforward with the auditor about Ender’s receivable. However, he
should consider the legal ramification of misrepresenting the company’s financial position to the bank and that the
auditor may also find out about Ender’s financial difficulties.
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PRACTICAL PROBLEMS
PRACTICAL PROBLEM NO.1- Ganesh Business

Mr. Ganesh is dealing in business. He was maintaining only some records which he thought were sufficient to run the
business. On April 1, 2019, available information from his records indicated that he had the following assets and
liabilities:
Particulars 4.1.2019 3.31.2020
Cash on Hand 10,000 16,000
Cash in Bank 20,000 36,000
Stock 16,000 24,000
Debtors 24,000 30,000
Creditors 15,000 18,000
Plant and machinery 60,000 90,000
Furniture and fixtures 18,000 18,000
Additional Information:
a. On 10.1.2019, Mr. Ganesh withdrew $8,000 cash for his private purpose and on the same date he sold
some of his house hold furniture for $2,000 and deposits this amount into his Bank Account of business.
b. Provide interest on capital @ 5% per annum on opening balance and Interest on drawing (only on cash
drawings) @10% per annum.
c. Depreciate plant and machinery @10 %( assuming additions were made on 10.1.2019) and furniture at 5%.
d. Write off bad debts $2,000 and provide Reserve for Doubtful debts at 10 % on debtors.
Questions:
1. Prepare Opening Statement of affairs.
2. Closing statement of affairs and
3. The statement of profit or loss for the year ended March 31, 2020.
Requirement 1: Opening Statement of affairs
Statement of Affairs
As of April 01, 2019
ASSETS AMOUNT ($) LIABILITIES AMOUNT ($)
Current Assets: Current Liabilities:
Cash on Hand 10,000 Creditors 15,000
Cash in Bank 20,000
Stock 16,000
Debtors 24,000
Total Current Assets 70,000 Total Current Liabilities 15,000
Fixed Assets: Owner’s Equity:

Furniture and Fixtures 18,000 Opening Capital (balancing 133,000
Figure)
Plant and Machinery 60,000
Total Fixed Assets 78,000
Total Assets 148,000 Total Liabilities and OE 148,000
Requirement 2: Closing statement of affairs

As of March 31, 2020
Cash in Bank 36,000
Stock 24,000
Debtors 30,000
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Fixed Assets: Owner’s Equity:
Furniture and Fixtures 18,000 Closing Capital (balancing 196,000
Figure)

Requirement 3: Statement of profit or loss for the year ended March 31, 2020
Statement of Profit or Loss
For the year ended March 31, 2020
PARTICULARS AMOUNT ($)
Closing Capital 196,000
Add: Drawings made during the year 8,000
Less: Additional Capital introduced during the year 2,000
Adjusted Closing Capital 202,000
Less: Opening Capital 133,000
Trading Profit 69,000
Less: Depreciations
-Opening Machinery (60,000x10%x12/12) 6,000
-Additional Machinery (30,000x10%x6/12) 1,500
-Furniture and Fixtures (18,000x5%) 900
Total Depreciation 8,400
Less: Write-off Bad Depts. 2,000
Reserve for Doubtful Debts (30.000-2,000x10%) 2,800
Less: Interest on Capital (133,000x5%) 6,650
Add: Other Income
-Interest on Drawings (8,000x10%x6mos) 400
Net Profit for the year 49,550
PRACTICAL PROBLEMS NO.2- Asha And Ushu Partnership

Asha and Usha were partners sharing profits and losses in the ratio of 2:1. Prepare their Statement of Profit or Loss for
the fiscal year ended 31st March, 2020 from the following statement of Affairs as on April 1, 2019:
As of April 01, 2019
Cash in Bank 6,000 Bills Payable 9,000
Stock 18,000
Debtors 25,000
Bills Receivable 13,000
Fixed Assets: Capitals:

Building 41,000 Asha 62,000
Furniture and Fixtures 10,000 Usha 32,000
Plant and Machinery 21,000 94,000

The assets and liabilities as of 31st March 2020 were: Creditors $35,000 Bills Receivable $18,000 Bills payable $15,000
Cash on Hand $3,000, Stock $32,000 Cash in Bank $6,000 Debtors $38,000. There were no changes in fixed assets.
Additional Information:
1. Asha and Usha had drawn $10,000 and $8,000 respectively for personal use.
2. They also brought additional capital of $6,000 and $4,000 respectively
3. Building to be depreciated by 5% and machinery and furniture at 10%.
4. Charge interest at 10% p.a. on opening capitals and allow interest on drawings of Asha and Usha were $700 and
$500 respectively.
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Question:
Prepare their Statement of Profit or Loss for the fiscal year ended 31 st March, 2020 from the following
statement of Affairs as on April 1, 2019.
As of March 31, 2020
Cash in Bank 6,000 Bills Payable 15,000
Stock 32,000
Debtors 38,000
Bills Receivable 18,000
Fixed Assets: Capitals:

Building 41,000 Closing Capital (balancing Figure) 119,000
Furniture and Fixtures 10,000
Statement of Profit or Loss

For the year ended March 31, 2020
PARTICULARS AMOUNT ($) AMOUNT ($)
Closing Capitals 119,000
Add: Drawings made during the year
Asha 10,000
Usha 8,000 18,000
Less: Additional Capital introduced during the year

Asha 6,000
Usha 4,000 10,000
Adjusted Closing Capital 127,000
Less: Opening Capital
Asha 62,000
Usha 32,000 94,000
Less: Depreciation (bldg+Machinery+Furniture) 5,150
-Interest on Capitals Asha 6,200
Usha 3,200 9,400
Add: Other Income
-Interest on Drawings
Asha 700
Usha 500 1,200
Profit for the year 19,650

Asha 13,100
Usha 6,550 19,650
PRACTICAL PROBLEM NO.3- Cash/Accrual - Blue Corporation

In line with your audit of Blue Corporation for the period ended December 31, 2020, your audit staff provided you the
following audit notes:
Audit notes:
a. Accounts receivables from customers increased during the year by P4,200,000. Total discounts taken by
customers was at P1,580,000 while total sales returns which included the customer refunds was at
P2,420,000.
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b. The allowance for bad debts increase during the year by P840,000. During the year, the company wrote-off
P1,120,000 in bad debts. While recovery of previous write-off (included in the cash collections from
customers) was at P420,000.
c. Advances from customers decreased during the year by P1,900,000.
d. Accounts payable to suppliers increased during the year by P3,780,000. Total discounts taken by the
company for purchases was at P1,290,000 while total purchase returns which included the supplier refunds
was at P1,960,000,
e. Advances to suppliers increased during the year by P1,512,000.
f. Inventories increased during the year by P2,690,000.
g. The equipment account increased by P2,000,000 during the year while carrying value of the equipment sold
during the year was at P1,600,000.
h. The accumulated depreciation account increased by P1,000,000 during the year.
i. The following information had been provided by the company's accountant based on its cash records:
Cash collections from customers P45,780,000

Cash payments to suppliers 24,490,000
Cash payments of operating expenses 8,650,000
Cash payment for acquisition of an Equipment 5,000,000
Cash collection from disposal of an Equipment 1,040,000
Cash refunds received from purchase returns 640,000
Cash refunds paid for sales returns 830,000
Questions:
1. What is the accrual basis gross sales?
2. What is the accrual basis gross purchases?
3. What is the accrual basis cost of sales?
4. What is the correct bad debt expense for the year?
5. What is the correct depreciation expense?
Cash collection from customers 45,780,000
Add: Sales discounts 1,580,000
Sales returns, excluding refunds 1,590,000
Write-off of receivables 1,120,000
Decrease in advances from customers 1,900,000
Increase in accounts receivables 4,200,000
Total 56,170,000
Less: Recoveries of previous write-off (420,000)
1. Accrual basis gross sales 55,750,000
Cash payments to suppliers of inventory 24,490,000

Add: Purchase discounts 1,290,000
Purchase returns, excluding refunds 1,320,000
Increase in accounts payable 3,780,000
Total 30,880,000
Less: Increase in advances to suppliers (1,512,000)
2. Accrual basis gross purchases 29,368,000
Accrual basis gross purchases 29,368,000

Less: Purchase discounts (1,290,000)
Purchase returns (total) (1,960,000)
Net Purchases 26,118,000
Less: Increase in Inventories (2,690,000)
3. Cost of Sales 23,428,000
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Increase in allowance for bad debt 840,000
Add: Write-off of AR 1,120,000)
Less: Recovery of previous write-off (420,000)
4. Bad debt expense 1,540,000
Increase in accumulated depreciation 1,000,000

Decrease in accum depr from equipment sold* 1,400,000
5. Depreciation expense for the Year 2,400,000
Increase in Equipment account 2,000,000
Purchase of Equipment during the year 5,000,000

Cost of Equipment sold during the year 3,000,000
Carrying value of equipment sold 1,600,000
Accum Depr. of equipment sold during the year 1,400,000
PRACTICAL PROBLEM NO.4- Adjusted Net Income/Loss and RE

A CPA is engaged by the Sony Corporation in 2006 to examine the books and records and to make whatever
corrections are necessary. An examination of the accounts discloses the following:
a. Dividends had been declared on December 15 in 2004 and 2005 but had not been entered in the books until paid.
b. Improvements in building and equipment of P9,600 had been debited to expense at the end of April 2003.
Improvements are estimated to have an 8-year life. The company uses the straight-line method in recording
depreciation and computes depreciation to the nearest month.
c. The physical inventory of merchandise had been understated by P3,000 at the end of 2004 and by P4,300 at the
end of 2005.
d. The merchandise inventories at the end of 2005 and 2006 did not include merchandise that was then in transit and
to which the company had title. These shipments of P3,800 and P5,500 were recorded as purchases in January
of 2006 and 2004, respectively.
e. The company had failed to record sales commissions payable of P2,100 and P1,700 at the end of 2005 and 2006,
respectively.
f. The company had failed to recognized supplies on hand of P1,200 and P2,500 at the end of 2005 and 2006,
respectively.
The Retained Earnings account showed the following postings:

Date Item Debit Credit
2004 Jan 1 Balance 81,000
Dec 31 Net income for year 18,000
2005 Jan 10 Dividends paid 15,000
Mar 6 Stock sold – excess
over par 32,000
Dec31 Net loss for year 11,200
2006 Jan 10 Dividend paid 15,000
Dec 31 Net loss for year 12,400
Questions:
1. Corrected net income of 2004
2. Corrected net loss of 2005
3. Corrected net loss 2006
4. Adjusted retained earnings at December 31, 2004
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Suggested Solution:
2004 2005 2006

Unadjusted Net income/Loss 18,000 (11,200) (12,400)
Item B (1,200) (1,200) (1,200)
Item C 3,000 (3,000)
4,300 (4,300)
Item D – unrecorded ending inv. 3,800 (3,800)
5,500
- unrecorded purchases (3,800) 3,800
(5,500)
Item E (2,100) 2,100
(1,700)
Item F 1,200 (1,200)
___________ __________ 2,500
1-2-3)Adjusted net income/loss 19,800 (12,000) (16,200)
4-5)Retained earnings – beg. 81,000 94,600 67,600
Item A (15,000) (15,000)
Item B – error in recording improv. 9,600
- unrecorded depreciation (800) _________ ____________
6.) Retained earnings - end 94,600 67,600 51,400
PRACTICAL PROBLEM NO.5- Franzine Gomez Co.

The before tax income for Franzine Gomez Co. for 2005 was P303,000 and P232,200 for 2006. However, the
accountant noted that the following errors had been made:
1. Sales for 2005 included amounts of P114,600 which was received in cash during 2005, but for which the related
products were delivered in 2006. Title did not pass to the purchaser until 2006.
2. The inventory on December 31, 2005, was understated by P25,920.
3. The bookkeeper in recording interest expense for both 2005 and 2006 on bonds payable made the following entry:
Interest expense 15,000
Cash 15,000
The bonds have a face value of P250,000 and pay a stated interest rate of 6%. They were issued at a discount of
P15,000 on January 1, 2005, to yield an effective interest of 7%. (Assume that the effective yield method should
be used.)
4. Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2005 and 2006 for
P25,500 and P30,000, respectively. The company applies a rate of 10% to the balance in the equipment account
at the end of the year in its determination of depreciation charges.
Questions:
1. Entries from 1-4
2. The adjusted 2005 net income
3. Adjusted 2006 net income
1. Retained earnings 114,600

Sales 114,600
2. Cost of sales (beg. inv) 25,920
Interest expense 1,552
Discount on bonds payable 3,002
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Int. paid Int. exp. Amort. Carrying Value
235,000
2005 15,000 16,450 1,450 236,450
2006 15,000 16,552 1,552 238,002

Repairs expense 30,000
Equipment 55,500
Accumulated depreciation 5,100
Depreciation expense 2,550
Accumulated depreciation 3,000
Depreciation expense 3,000
2005 2006
Unadjusted net income 303,000 232,200
Item 1 (114,600) 114,600
Item 2 25,920 (25,920)
Item 3 (1,450) (1,552)
Item 4 (25,500) (30,000
- error in recording depreciation 2,550 2,550
__________ 3,000
1-2) Adjusted net income 189,920 294,878
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OUTLINE
1. Overview
1.1. Objective
1.2. Scope
1.3. Effective Date
2. The Five-Step Revenue Recognition Model

2.1 Identify the Contract
2.1.1 Attributes of a contract
2.1.2 Combination of contracts
2.1.3 Contract modifications
2.2 Identify the performance obligation(s) in the contract

2.2.1 Single performance obligation in the contract
2.2.2 Multiple performance obligations in the contract
2.3 Determine the transaction price

2.3.1 Variable consideration
2.3.2 Significant financing component
2.3.3 Non-cash consideration
2.3.4 Consideration paid or payable to customers
2.4 Allocate the transaction price to the performances in the contract

2.4.1 Determining stand-alone selling price
2.4.2 Allocating the discount
2.4.3 Allocating the variable consideration
2.4.4 Changes in Transaction Price
2.5 Recognize revenue as or when the entity satisfies a performance obligation

2.5.1 Transfer of control
2.5.2 Performance obligation satisfied over time
2.5.3 Performance obligation satisfied at a point in time
3. Sample problems
3.1 Property developer and revenue over time or at a point in time
3.2 Software development and splitting the contract into two separate contracts
3.3 Long-term construction contract
3.4 Consignment sales
3.5 Long-term construction contract
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IFRS 15: REVENUE FROM CONTRACTS WITH CUSTOMERS
OVERVIEW
International Financial Reporting Standard (IFRS) 15, Revenue from contract with customers, was issued on
May 28, 2014 by the International Accounting Standards Board (IASB). It supersedes:
• IAS 18 Revenue
• IAS 11 Construction contracts
• IFRIC-13 Customer Loyalty Programs
• IFRIC-18 Transfers of Assets from Customers
• SIC-31 Revenue – Barter Transactions Involving Advertising Services
Objective
To establish principles that an entity shall apply to report useful information to users of financial statements
about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer
Scope
IFRS 15 applies to all entities and all contracts with customers to provide goods or services in the ordinary
course of business, except for the following contracts, which are specifically excluded:
• Lease contracts (IFRS 16)
• Insurance contracts (IFRS 4)
• Financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial
Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate
Financial Statements and IAS 28 Investments in Associates and Joint Ventures.
• Non-monetary exchanges between entities in the same line of business to facilitate sales to customers
or potential customers.
Effective date
IFRS 15 became effective for annual reporting periods beginning on or after 1 January 2018.
THE FIVE-STEP REVENUE RECOGNITION MODEL
The standard introduces a revenue model in which the core principle is that an entity should recognize revenue
to depict the transfer of promised goods or services to the customer in an amount that reflects the consideration to
which the entity expects to be entitled in exchange for those goods or services.
To recognize revenue, the following five steps should be followed:
Step 1: Identify the contract with the customer
To apply the five-step model in IFRS 15, an entity must first identify the contract, or contracts, to provide goods
or services to customers. A contract must create enforceable rights and obligations to fall within the scope of the
model in the standard. Such contracts may be written, oral or implied by an entity’s customary business practices.
 Attributes of a contract
To help entities determine whether (and when) their arrangements with customers are contracts within
the scope of the model in the standard, the Board identified certain attributes that must be present, as follows:
 The parties have approved the contract and are committed to perform their respective obligations.
 Each party’s rights regarding the goods or services to be transferred can be identified.
 Payment terms can be identified.
 The contract has commercial substance.
 It is probable that the entity will collect the consideration to which it will be entitled in exchange for
the goods or services that will be transferred to the customer.
If a customer contract does not meet these criteria, revenue is recognized only when either:
 The entity’s performance is complete and substantially all of the consideration in the arrangement
has been collected and is non-refundable.
 The contract has been terminated and the consideration received is non-refundable.
 Combination of contracts
An entity is required to combine two or more contracts and account for them as a single contract if they
are entered into at or near the same time and meet one of the following criteria:
 The contracts are negotiated together with a single commercial objective.
 The consideration to be paid for one contract is dependent on the price or performance of another
contract.
 The goods or services promised in the contracts are a single performance obligation.
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 Contract modifications
Parties to an arrangement frequently agree to modify the scope or price (or both) of their contract. If that
happens, an entity must determine whether the modification is accounted for as a new contract or as part of
the existing contract.
The following flowchart illustrates the key decision points to consider when determining whether a contract
modification should be accounted for as part of the original contract or separate contract.
Step 2: Identify the performance obligation(s) in the contract.

A performance obligation is a promise in a contract to provide a product or service to a customer. This promise
maybe implicit, explicit, or possibly based on the usual business practices. To establish whether a performance
obligation exists, the company must provide a distinct product or service.
A good or service is “distinct” if both of the following criteria are met:
Criterion 1: Can the customer benefit from the good or service on its own or together? And
Criterion 2: Is the entity’s promise to transfer the good or service separately identifiable from other promises
in the contract?
o If performance obligation is not highly dependent on, or interrelated with, other promises in the
contract, then each performance obligation should be accounted separately.
o If each of these services is interdependent and interrelated, these services are combined and
reported as one performance obligation.
Good or service is capable of being distinct. A customer can benefit from a good or service if it can be used,
consumed, sold for an amount that is greater than scrap value or otherwise held in a way that generates economic
benefits.
The objective when assessing whether an entity’s promises to transfer goods and services are distinct within
the context of the contract is to determine whether the nature of the promise is to transfer each of those goods or
services individually, or whether the promised goods or services are inputs.
If a promised good or service is determined not to be distinct, then an entity continues to combine it with other
promised goods and services until it identifies a bundle of goods or services that is distinct. In some cases, these
results in the entity accounting for all the goods and services promised in a contract as a single performance
obligation.
Illustration 1: Single performance obligation in a contract
Dimagiba Construction Company enters into a contract with customer Mati Bay to design and build a
hospital. DCC is responsible for the overall management of the project and identifies goods and services to
be provided including engineering, site clearance, foundation, procurement, construction, piping and wiring,
installation of equipment and finishing.
Explanation:
DCC identifies goods and services that will be provided during the hospital construction that might
otherwise benefit Mati Bay on its own. However, DCC notes that the goods and services to be provided
under the contract are not separately identifiable from the other promises in the contract. Instead, DCC is
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providing a significant integration service by combining all of the goods and services in the contract into the
combined item for which Mati Bay has contracted.
Therefore, DCC concludes that the second criterion is not met and that the individual activities are not
distinct and therefore are not separate performance obligations. Therefore, it accounts for the bundle of
goods and services to construct the hospital as a single performance obligation.
Illustration 2: Multiple performance obligations in a contract
Corona Computers manufactures and sell computers to Virus that includes a warranty to make good on
any defect in its computers for 150 days (often referred to as an assurance warranty). In addition, it sells
separately an extended warranty, which provides protection from defects for three years beyond the 150
days (often referred to as a service warranty).
Explanation:
In this case, two performance obligation exist, one related to the sale of the computer and the assurance
warranty, and the other to the extended warranty (service warranty)
The sale of the computer and related assurance warranty are one performance obligation as they are
interdependent and interrelated with each other. However, the extended warranty is separately sold and is
not interdependent.
Step 3: Determine the transaction price

The transaction price is the amount of consideration to which the entity expects to be entitled in exchange for
transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
Components to be consider in determining the transaction price:
 Variable consideration – an entity estimates the amount of variable consideration to which it expects to
be entitled, giving consideration to the risk of revenue reversal in making the estimate. (eg. incentive
payments, royalties, volume discounts, rebates, penalties, right of return etc.
 Significant financing component – an entity adjusts the promised amount of consideration to reflect the
time value of money.
 Non-cash consideration – it is measured at fair value, if that can be reasonably estimated; if not, then
an entity uses the stand-alone selling price of the good or service that was promised in exchange for
non-cash consideration.
 Consideration payable to a customer – an entity needs to determine whether the consideration payable
to a customer represents a reduction of the transaction price, a payment for a distinct good or service,
or a combination of two.
 Variable Consideration
An entity assesses whether, and to what extent, it can include an amount of variable consideration in the
transaction price at contract inception. And an entity recognizes a refund liability for consideration received or
receivable if it expects to refund some or all of the consideration of the customer.
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Illustration 1: Enterprise service contract with penalties
Spatlite enters into an agreement to provide data hosting services to a large business customer Sikat
Co., for a period of five years. Certain service-level agreements (SLAs) are signed by Spatlite as part of the
contract with Sikat Company. Specifically, the SLAs will result in a reduction of consideration paid by Sikat
to Spatlite, if Spatlite does not meet a special level of service. Because the SLAs are not part of the contract
with Sikat, the SLA penalties create variable consideration
Therefore, Spatlite estimate the account of the penalties at contract inception in determining the
transaction price.
Estimate variable consideration using either:
 Expected Value – calculated as the sum of each probability-weighted amounts for a range of
possible consideration amounts. This may be appropriate estimate of the amount of variable
consideration if an entity has a large number of contracts with similar characteristics
 Most likely amount – the entity considers from a range of possible consideration amounts. This
may be an appropriate estimate of the amount of variable consideration if the contract has only
two (or perhaps a few) possible outcomes.
Illustration 2: Estimate of variable consideration: Expected Value
Electron Manufacturer sells 1,000 televisions to Tyler for P500,000. Electron provides price protection to
Tyler by agreeing to reimburse Tyler for the difference between the price and the lowest price that it offers
for that television during the following six months. Based on Electron’s extensive experience with similar
agreements, it estimates the following outcomes.
Price reduction in next six month Probability
0 70%
50 20%
100 10%
Suggested Answer:
0 – (500*70%) 350
50 – (450*20%) 90
100 – (400*10) 40
Estimated transaction price 480
Illustration 2: Estimate of variable consideration: Most likely amount

Billder Company enters into a contract with Pekto to build a house. Depending on when the house is
completed, Billder will receive either P110,000 0r P130,000.
Outcome Consideration Probability
Project completes on time 130,000 90%
Project is delayed 100,000 10%
Suggested Answer:
Billder Company will estimate the transaction price – before it considers the constraint to be P130, 000,
which is the single most likely amount
Historical experience may be a source of evidence. An entity only includes an estimate of variable
consideration in the transaction price to the extent it is probable that a significant revenue reversal will not
occur when the uncertainty associated with the variable consideration is resolved.
 Significant Financing Component

To estimate the transaction price in a contract, an entity adjusts the promised amount of consideration for
the time value of money if that contract contains a significant financing component. And the objective when
adjusting the promised amount of consideration for a significant financing component is to recognize revenue
at an amount that reflects what the cash selling price of the promised good or service would have been if the
customer has paid cash at the same time as control of that good or service transferred to the customer. The
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discount rate used is the rate that would be reflected in a separate financing transaction between the entity
and the customer at contract inception.
Illustration: Extended payment terms
On Sept. 1, 2020, Duzer Company sold goods to Billy for P450,000 in exchange for a 4-year, zero-
interest-bearing note with a face amount of P708,081.50. The goods have a cost on Duzer’s books of
P295,000.
September 1, 2020: Record at the sale
Notes Receivable 708,081.50
Sales 450,000.00
Unearned Interest Income 258,081.50
Cost of Sales 295,000.00
Inventory 295,000.00
December 31, 2020: Record interest revenue

Unearned Interest Income (discount on Notes 18,000
Payable)
Interest Income (12%*4/12*450,000) 18,000
 For practical considerations, companies are not required to reflect the time value of money if the time
period for payment is less than a year.
 Non-cash Consideration
Entities sometimes receive contributions such as donations and gifts. And customer sometimes
contributes goods or services, such as equipment or labor, as consideration for goods provided or services
performed. Non-cash consideration received from a customer is measured at fair value. If an entity cannot
make a reasonable estimate of the fair value, then it refers to the estimated selling price of the promised goods
or services.
Estimates of the fair value of non-cash consideration may vary. Although this may be due to the
occurrence or non-occurrence of a future event, it can also vary due to the form of the consideration. And
those changes are reflected in the transaction price and are subject to the guidance on constraining variable
consideration.
Non-cash consideration received from the customer to facilitate an entity’s fulfillment of the contract is
accounted for if and when the entity obtains control of those contributed goods and services. This practice is
similarly situated with non-for-profit organization.
Illustration: Non-cash consideration
Emi Company sells a television show to GMA-CBN5. The consideration under the arrangement is a fixed
amount of P1,000 and 100 advertising slots. Emi determines that the stand-alone selling price of the show
would be P1,500. Based on the market rates, Emi determines that the fair value of the advertising slots is
P600.
Explanation:
Emi determines that the transaction price is 1,600, comprising the 1,000 fixed amount plus the fair value
of the advertising slots.
If the fair value of the advertising slots could not be reasonably estimated, then the transaction price of
the goods or services promised for the non-cash consideration in these circumstances.
 Consideration Paid or Payable to Customers
Consideration payable to a customer includes cash amounts that an entity pays or expects to pay to the
customer or to other parties that purchase the entity’s goods or services to pay to the customer. Consideration
payable to a customer also includes credits or items such as coupon or voucher that can be applied by the
customer against the amount owed to the entity of to the other parties that purchase the entity’s goods or
services from the customer. In general, these elements reduce the consideration received and the revenue to
be recognized.
 If the seller is purchasing distinct goods or services from the customer at the fair value of the goods
or services, we account for that purchase as a separate transaction
 If a seller pays more for distinct goods or services purchased from their customer than the fair value
of those goods or services, those excess payments are viewed as a refund. They are subtracted
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from the amount the seller is entitled to receive from the customer when calculating the transaction
price of the sale to the customer.
Illustration: Payments to customers: Reduction in the transaction price
Batt Corp. enters into a one-year contract with Covi to sell goods. Covi commits to buying atleast
P1,500,000 worth of the products durong the year. Batt also makes a non-refundable payment of 150,000
to Covi at contract inception to compensate Covi for the changes that it needs to make to its shelving to
accommodate Batt’s product.
Explanation:
The transaction price would be P1,350,000. Batt concludes that the payment of Covi is not in exchange
for a distinct good or service, because Batt does not obtain control of the rights to the shelves. Consequently,
Batt determines that the payment of 150,000 is a reduction in the transaction price when it recognizes
revenue for the transfer of goods.
Step 4: Allocate the transaction price to the performance obligation.

The transaction price is allocated to each performance obligation to determine the amount of consideration to
which an entity expects to be entitled in exchange for transferring the promised goods or service to the customers.
An entity generally allocates the transaction price in proportion to the stand-alone selling prices of the goods or
services.
 Determining stand-along selling prices
The stand-alone selling price is the price at which an entity would sell a promised good or service
separately to a customer under similar circumstances. These prices are determined at contract inception and
are not updated to reflect changes between contract inception and when performance is complete. However,
for future contracts involving the same good, the entity would need to determine whether the change in
circumstances warrants a revision of the stand-alone selling price. If so, the entity would use that revised price
for allocations in future contracts.
In some cases, where the stand-along selling price is not directly observable, the entity estimates the
amount using a suitable method. The standard does not preclude or prescribe any particular method for
estimating the stand-alone selling price but it describes the following estimation methods as possible
approaches.
a. Adjusted market assessment approach
Evaluating the market in which goods or services are sold and estimate the price that customers
in the market would be willing to pay.
b. Expected cost plus a margin approach
Forecasting the expected costs of satisfying a performance obligation and then adding an
appropriate margin for that good or service
c. Residual approach
Subtracting the sum of the observable stand-alone selling prices of other goods or services
promised from the total transaction price.
Illustration: Estimating stand-alone selling price using the Residual Method
Software vendor M enters into a contract with Customer C to provide rights to use Licenses S and T for
three years, as well as PCS services for both licenses. The contract price is 100,000.
The PCS services comprise telephone technical support for each license. M has identified four
performance obligations:
 License S;
 PCS services for S;
 License T; and
 PCS services for T
The stand-alone observable price of 12,500 is available for the technical support for each of the licenses,
based on renewals that are sold separately. However, the prices of Licenses S and T are not directly
observable. M estimates the stand-alone selling prices of the performance obligations in the contract as
follows:
Products Stand-alone selling price Approach
Licenses S and T 75,000 Residual approach (100,000-12,500-

12,500)
PCS for S 12,500 Directly observable price
PCS for T 12,500 Directly observable price
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M uses the residual approach to estimate the stand-alone selling price for the bundle of products (S and
T) with highly variable selling prices. Because the licenses will transfer to C at different points in time, M
then estimates the stand-alone selling price of each license. It does this by allocating the 75,000 to S and T
based on the average stand-alone selling price determined using the residual approach over the past year,
as follows:
Performance Average Residual Selling Price Ratio Price Allocation Calculation
Obligation Selling Prices
License S 40,000 40% 30,000 (75,000*40%)
License T 60,000 60% 45,000 (75,000*60%)
Total 100,000 100% 75,000
An entity would not apply the allocation requirements if the contract has only one performance obligation
(except for a single performance obligation that is made up of a series of distinct goods and services and
includes variable consideration).
Once an entity has determined the stand-alone selling price for the separate goods and services in a
contract, the entity allocates the transaction price to those performance obligations based on the proportion
of the stand-alone selling price of each performance obligation to the sum of the stand-alone selling prices
of all of the performance obligations in the contract, unless the contract includes a discount and/or variable
consideration. This method is known as the relative stand-alone selling price.
Illustration: Allocating transaction price using relative stand-alone selling price method
NCT enters into a 12-month phone contract in which a customer is provided with a handset and a plan
that includes data, calls and texts (the wireless plan) for a price of 35 per month. NCT has identified the
handset and the wireless plan as separate performance obligations. NCT sells the handset separately for a
price of 200, which provides observable evidence of a stand-alone selling price. NCT also offers a 12-month
service plan without a phone that includes the same level of data, calls and texts for a price of 25 per month.
This pricing is used to determine the stand-alone selling price of the wireless plan as 300 (25 × 12 months).
NCT allocates the transaction price of 420 (35 × 12 months) to the performance obligations based on their
relative stand-alone selling prices as follows.
Performance Stand-alone Selling Price Price Allocation Calculation
Obligation Selling Prices Ratio
Handset 200 40% 168 (420*40%)
Wireless Plan 300 60% 252 (420*60%)
Total 500 100% 420
 Allocating the Discount

In some cases, where the sum of the stand-alone selling prices of the goods or services exceeds the
promised consideration, a discount will be generally allocated to all the performance obligations in the contract.
However, this does not apply if there is observable evidence that the discount is traceable only to one or more
performance obligations, but not all. This is applicable if all criteria are met:
 The entity regularly sells each distinct good or service, or each bundle of distinct goods or
service, in the contract on a stand-alone basis;
 The entity also regularly sells, on a stand-alone basis, a bundle of some of those distinct goods
or services at a discount to the stand-alone selling prices of the goods or services in each bundle;
and
 The discount attributable to each bundle of goods or services is substantially the same as the
discount in the contract, and an analysis of the goods or services in each bundle provides
observable evidence of the performance obligation(s) to which the entire discount in the contract
belongs.
Illustration 1: Discount allocated to one or more, but not all, performance obligations
NCT enters into a contract with a residential customer to sell phone, internet and television services for a
total amount of 120. NCT regularly sells the products individually for the following prices:
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Phone 40
Internet 55
Television 45
Total 140
NCT also regularly sells phone and internet services together for 75.
The contract includes a total discount of 20 (140-120) on the overall transaction, which is allocated
proportionately to the three services in the contract when applying the relative stand-alone selling price
method. However, because C regularly sells phone and internet service for 75 (at a discount of 20), and
television services for 45, it has evidence that the discount should be allocated only to the phone and internet
services.
Performance Stand-alone Selling Price Price Allocation Calculation
Obligation Selling Prices Ratio
Phone 40 42% 32 (40*42%)
Internet 55 58% 43 (55*58%)
Total 95 100% 75
NCT recognizes revenue of 32 for phone, 43 for internet and 45 for television services.
Illustration 2: Bundle discount allocated to the entire contract
RV offers phone, internet, and television services to residential customer at 20, 30, 40 per month,
respectively. If a customer contracts for either phone and internet or internet and television services, then
RV gives a discount of 5. If a customer takes all three services, then RV gives a discount of 10. Because
the discount attributable is not the same and the analysis of the services in each bundle does not provide
observable evidence that the discount relates to just one or two services, the discount of 10 is allocated to
all three services as shown below:
Performance Stand-alone Selling Allocation of Discount Price Allocation
Obligation Price
Phone 20 10*20/90 18
Internet 30 10*30/90 27
Television 40 10*40/90 35
 Allocating the Variable Consideration

Variable consideration, as discussed in Step 3, may be attributable to:
 All of the performance obligations in the contract;
 One or more, but not all performance obligations;
 One or more, but not all of the distinct goods or services promised in a series of distinct goods
or services that forms part of a single performance obligation.
An entity shall allocate a variable amount (and subsequent changes to that amount) entirely to a
performance obligation or to a distinct good or service that forms part of a single performance obligation if
both of the following criteria are met:
 The terms of a variable payment relate specifically to the entity’s efforts to satisfy the
performance obligation or transfer the distinct good or service (or to a specific outcome from
satisfying the performance obligation or transferring the distinct good or service); and
 Allocating the variable amount of consideration entirely to the performance obligation or the
distinct good or service is consistent with the allocation objective when considering all of the
performance obligations and payment terms in the contract.
If a contract contains different types of variable consideration, then an entity applies the requirement in
the standard separately to each type.
In some cases, which consist both fixed and variable considerations, the latter may be attributed to one
or more, but not all, distinct goods or services promised in the series. This allows an entity, in some cases, to
attribute the reassessment of variable consideration to only the satisfied portion of the performance obligation,
if that performance obligation is a series of distinct goods or services.
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Illustration 1: Variable consideration allocated entirely to one performance obligation in the contract
SM Co., enters into a contract with Customer N for two pieces of equipment, Equipment X and Equipment
Y. SM determines that X and Y represent two performance obligations each satisfied at a point in time. The
stand-alone selling price of X and Y are 800 and 1000, respectively.
The price stated in the contract of X is a fixed amount of 1000. As for Y, the price is 800 if the equipment
is used by N to produce 1000 products or less in Year 1 and 1000 if it's used to produce more than 1000 in
Year 1. SM estimates that it will be entitled to variable consideration of 1000 and that it is highly probable
that a significant reversal in the amount of cumulative revenue recognized will not occur.
SM allocates that the estimated 1000 in variable consideration entirely to Y because:
 The variable payment relates to Y; and
 The estimated amount of variable consideration and the fixed amount for X approximate the
stand-alone selling prices of each product.
SM recognizes revenue of 800 for X and 1000 for Y, when control of the good is transferred to N.
Illustration 2: Series of distinct services
Company X is an electricity provider. It enters into a contract with Customer C to supply electricity for one
year on the following terms:
 The amount and timing of the electricity supply are at C's discretion (i.e. quantity is variable).
 The fee includes a fixed and a usage-based component.
 The fixed fee is 1200 and is payable on monthly instalments.
 The usage-based fee is a standard price of 1 per kWh and is payable at the end of each
month. The price per kWh is fixed for the whole contract period.
X determines that it has a stand-ready obligation to supply electricity because the amount and timing of
the supply are at C's discretion. X also determines that this stand-ready obligation is a series because:
 Each increment of X's services is distinct and has the same pattern of transfer to C;
 C simultaneously receives and consumes the benefits of the electricity as it is provided; and
 X would use the time-based method to measure its progress in transferring each increment of
its services to C.
X allocates the fixed fee on a straight line basis throughout the year because the fee relates to a stand-
ready obligation. The variable fee will be allocated based on the daily or monthly consumption since
according to the agreement consideration is allocated only to the satisfied portion of the performance
obligation.
Note: In cases where a contract contains both a discount and a variable consideration, the guidance on
allocation of variable consideration is applied before the guidance on allocation of discount.
 Changes in Transaction Price
Even after the contract inception, the transaction price may still change due to various reasons such as
the occurrence of uncertain events or other changes in the circumstances that may affect the amount of
consideration.
Changes in the total transaction price are generally allocated to the performance obligations on the same
basis as the initial allocation, whether they are allocated based on the relative stand-alone selling price or to
individual performance obligations under the variable consideration exception. Amounts allocated to a
satisfied performance obligation should be recognised as revenue, or a reduction in revenue, in the period
that the transaction price changes.
Changes resulting from contract modification are accounted for under the standard's contract modification
guidance. If the change in price resulted from a contract modification, it is allocated to the performance
obligations in the modified contract such as those that were unsatisfied or partially unsatisfied immediately
after the modification, unless the:
 Change is attributable to an amount of variable consideration that was promised before the
modification; and
 Modification was accounted for as a termination of the existing contract and creation of a new
contract.
Any portion of a change in transaction price allocated to a satisfied obligation is recognized as revenue
or as a reduction in revenue, in the period where the price change took place.
Step 5: Recognize revenue when or as the entity satisfies a performance obligation

At contract inception, an entity first evaluates whether it transfers control of the good or service over time – if
not, then it transfers control at a point in time.
 Transfer of Control
A good or service is transferred to a customer when the customer obtains control of it. Control refers to
the customer’s ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset.
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It also includes the ability to prevent other entities from directing the use of, and obtaining the benefits from,
an asset.
Under IFRS 15, the transfer of control to the customer represents the transfer of the rights with regard to
the good or service. The customer’s ability to receive the benefit from the good or service is represented by
its right to substantially all of the cash inflows, or the reduction of the cash outflows, generated by the goods
or services. Upon transfer of control, the customer has sole possession of the right to use the good or service
for the remainder of its economic life or to consume the good or service in its own operations.
 Performance obligations satisfied over time
Frequently, entities transfer the promised goods and services to the customer over time. While the
determination of whether goods or services are transferred over time is straightforward in some contracts
(e.g., many service contracts), it is more difficult in other contracts.
IFRS 15.35 states that an entity transfers control of a good or service over time if one of the following
criteria are met:
 As the entity performs, the customer simultaneously receives and consumes the benefits
provided by the entity’s performance.
 The entity’s performance creates or enhances an asset (e.g., work in progress) that the
customer controls as the asset is created or enhanced.
 The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.
Note: If none of these criteria are met, revenue is recognized at a point in time.
 Performance does not create and asset with an alternative use
For an asset to have no alternative use to an entity, a contractual restriction on the ability to direct its use
has to be substantive such as an enforceable right. If an asset is largely interchangeable with other assets
and could be transferred to another customer without breaching the contract or incurring significant
incremental costs, then the restriction is not substantive.
 The entity has an enforceable right to payment for performance completed to date
An entity that is constructing an asset with no alternative use is effectively constructing the asset at the
direction of the customer. The contract will often contain provisions providing some economic protection
against the risk of the customer terminating the contract and leaving the entity with an asset of little or no
value.
Therefore, to demonstrate that a customer controls an asset that has no alternative use as it is being
created, an entity evaluates whether it has an enforceable right to payment for the performance completed to
date.
Illustration: Performance obligation satisfied overtime
Developer D is developing a multi-unit residential complex. Customer Y enters into a binding sales
contract with D for Unit X, which is under construction. Each unit has a similar floor plan and is a similar
size. The following facts are relevant.
 Y pays a non-refundable deposit on entering into the contract and will make progress
payments intended to cover costs to date plus the margin percentage in the contract during
construction of X.
 The contract has substantive terms that preclude D from being able to direct X to another
customer.
 If Y defaults on its obligations by failing to make the promised progress payments when they
are due, then D has a right to all of the consideration promised in the contract if it completes
the construction of the unit.
 The courts have previously upheld similar rights that entitle developers to require the customer
to perform, subject to the entity meeting its obligations under the contract.
At contract inception, D determines that because it is contractually prevented from transferring X to
another customer, X does not have an alternative use. In addition, if Y were to default on its obligations then
D would have an enforceable right to all of the consideration promised under the contract. Consequently,
Criterion 3 is met and D recognises revenue from the construction of Unit X over time.
 Measure progress toward completion
When an entity has determined that a performance obligation is satisfied over time, the standard requires
the entity to select a single revenue recognition method for the relevant performance obligation that faithfully
depicts the entity’s performance in transferring control of the goods or services. An entity should apply the
method selected consistently to similar performance obligations.
In addition, at the end of each reporting period, an entity is required to remeasure its progress toward
completion of the performance obligation. In determining the appropriate method for measuring progress, an
entity shall consider the nature of the good or service that the entity promised to transfer to the customer.
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Methods for measuring progress
 Output Method - Recognize revenue on the basis of direct measurements of the value to the
customer of the goods or services transferred to date relative to the remaining goods or services
promised under the contract. It should be noted that units-of-delivery or units-of-production may
not result in the best depiction of an entity’s performance over time if there is material work-in-
process at the end of the reporting period
 Input Method - Recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction
of a performance obligation such as resources consumed, labor hours expended, costs incurred,
time elapsed or machine hours used, relative to the total expected inputs to the satisfaction of
that performance obligation. In case the inputs are expended evenly throughout the period, it
may be appropriate to recognize revenue on a straight-line basis.
Illustration: Choosing the measure of progress
A ship-building entity enters into a contract to build 15 vessels for a customer over a three-year period.
The contract includes both design and production services. The entity has not built a vessel of this type in
the past. In addition, the entity expects that the first vessels may take longer to produce than the last vessels
because, as the entity gains experience building the vessels, it expects to be able to construct the vessels
more efficiently.
Assume that the entity has determined that the design and production services represent a single
performance obligation. In this situation, it is likely that the entity would not choose a ’units-of-delivery’
method as a measure of progress because that method would not accurately capture the level of
performance.
That is, such a method would not reflect the entity’s efforts during the design phase of the contract
because no revenue would be recognised until a vessel was shipped. In such situations, an entity would
likely determine that an input method is more appropriate, such as a percentage of completion method
based on costs incurred.
 Adjusting the measure progress
An entity applying an input method excludes the effects of any inputs that do not depict its performance
in transferring control of goods or services to the customer. In particular, when using a cost-based input
method – e.g. cost-to-cost – an adjustment to the measure of progress may be required when an incurred
cost:
 Does not contribute to an entity’s progress in satisfying the performance obligation: e.g.
unexpected amounts of wasted materials, labour or other resources (these costs are expensed
as they are incurred); or
 Is not proportionate to the entity’s progress in satisfying the performance obligation: e.g.
uninstalled materials.
 Performance obligations satisfied at a point in time
If a performance obligation is not satisfied over time, then an entity recognizes revenue at the point in
time at which it transfers control of the good or service to the customer. An entity has control of a good or
service when it has the ability to direct the use of, and obtain substantially all of the remaining benefits from,
the good or service.
The standard includes indicators of when the transfer of control occurs:
 A present obligation to pay
 Physical possession
 Legal title
 Risks and rewards of ownership
 Acceptance of the asset
Relevant considerations to note:
 In some cases, possession of legal title is a protective right and may not coincide with the transfer
of control of the goods or services to a customer
 In consignment arrangements an entity may have transferred physical possession but still retain
control. Conversely, in bill-and-hold arrangements, an entity may have physical possession of
an asset that the customer controls.
 In some arrangements, a customer may obtain control of an asset before it has physical
possession
 In some cases, the customer may have the rewards of ownership, but not the risks.
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SAMPLE PROBLEMS
SAMPLE PROBLEM NO. 1 – Property developer and revenue over time or at the point of time
SMDC, property developer, builds a residential building consisting of 50 condo units. Condo units have a similar size
and proportions but, they can be customized to clients’ preferences and needs.
SMDC enters into 2 contracts with 2 different clients A and B. Both clients want to buy almost identical units and agree
with total price of PHP 10,000, 000 per units. The payment schedule is as follows:
 Upon the signature of a contract, clients pay deposit of PHP 1,000, 000 each.
 Milestone: 1 year prior planned completion, SMDC will deliver progress reports to clients and clients need to
pay PHP 5,000, 000 each.
 Upon the completion of the construction, the legal ownership to units is transferred to clients and they pay
the remaining amount of PHP 4,000, 000 each.
Assumed period of construction is 2 years from the date of contract. SMDC has the right to retain the payments from
any client in the situation when that client defaults on the contract before its completion. The contractual terms specify
that:
 No other specific terms in the contract with client A.
 The contract with client B specifies that SMDC cannot transfer or direct the unit to another client and in return,
the client B cannot terminate the contract.
If the client B defaults, the contract before its completion in other words, does not make payments in line with the
schedule, SMDC has the right for all contractual price, if SMDC decides to complete the contract.
Question:
What’s the difference here?
Suggested Answer:
In the case of client A, the revenue would only be recognized at the point of time and revenue from contract B
will be over time. The contract with client A does not meet the third criterion. The reason is that SMDC builds a unit
that can be easily sold or transferred to another client in case of default. Even when this would be prevented by
writing specifically in the contract, SMDC has no enforceable right to payment for performance completed to date.
SMDC will keep only the progress payments in the case of client’s default and they may not cover entity’s cost for
work completed to date. This will results SMDC would recognize revenue at the point of time that is when the unit is
transferred to the client A upon the completion in the year 2. The contract with client B meets the third criterion. The
reason is that SMDC cannot direct the constructed asset for the alternative use, because the contract with client
B does not permit transfer of the unit to another client and SMDC has enforceable right to payment for performance
completed to date. In this case, SMDC recognizes revenue over time that is, over 2 years of construction of unit
based on some output or input method.
SAMPLE PROBLEM NO. 2 – Software development and splitting the contract into two separate obligations
Oracle is a software company who entered into contract with a client C on 1 July 20X1. Under the contract, Oracle is
obliged to:
 Provide professional services consisting of implementation, customization and testing of software. Client C
has bought software license from the third party.
 Provide post-implementation support for 1 after the customized software is delivered.
Total contract price is PHP 550, 000.
Oracle assessed its total cost for fulfilling the contract as follows:
 Cost of developers and consultants for implementing and testing the existing software: PHP 430, 000;
 Cost of consultants for post-delivery support: PHP 200, 000;
 Total estimated cost of fulfilling the contract: PHP 450, 000.
 Oracle’ normal charge for the support services is 10% of the package price, no matter what the package is
whether some ready-made license or customized software.
As of 31 December 20X1, Oracle incurred the following costs of fulfilling the contract:
 Cost of developers and consultants for development, implementation and testing the customized modules:
PHP 130, 000.
Question:
How should Oracle recognize revenue from this contract under IFRS 15?
Suggested Answer:
Revenue under the new rules (IFRS 15)
IFRS 15, states on whether the goods or services promised under the contract are distinct and whether they
can be considered separate performance obligations or not. Software customization services and post-delivery
support meet the definition of distinct performance obligations and as a result, they will be treated separately.
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There are separate components, and will be allocated the total transaction price of PHP 550, 000 based on
their relative stand-alone selling prices
Performance Estimated total Incurred cost Progress % Allocated Revenue
obligation cost (A) to 31-Dec-X1 (C)=(B)/(A) transaction recognized in
(B) price (D) 20X1 (D)*(C)
Professional 430, 000 130, 000 30% 500 000 150 000
services
Post-delivery 2 000 0 0% 50, 000 0
support
Total 450, 000 13 000 n/a 550, 000 150 ,000
SAMPLE PROBLEM NO. 3 – Long Term Construction Contract

COF Construction Inc., uses the percentage-of-completion method of recognizing income. In 2019, COF started work
on a 4,500,000 construction contract, which will be completed in 2012. The accounting records disclosed the following
data as of the end of last year:
 Progress billings 1,650,000
 Costs incurred (actual costs during 2019 on the contract) 1,350,000
 Collections 1,050,000
 Estimated cost to complete (during 2018) 2,700,000
Question:
How much income should COF have recognized on this contract in 2019?
Suggested Answer:
Compute the expected total profit on the contract as follows:
Contract revenue 4,500,000
Actual costs to date (1,350,000)
Estimated cost to complete (2,700,000)
Expected total profit 450,000
Compute the percentage of the project completed as follows:
Costs incurred/Total expected costs = Percentage of project completed
1,350,000/ (1,350,000 + 2,700,000) = 33.33%

Compute the amount of income to be reported to date as follows:
Expected total profit 450,000
Percentage of project completed X 33.33%
Income to be reported to date 150,000
Profit previously recognized 0
Income to be recognized 150,000
SAMPLE PROBLEM NO. 4 – Consignment Sales

The consignment-out ledger account for the month of July, 2018 in the accounting records of FEU Company for Morayta
Enterprises, a new consignee, as follows:
Consignment out- Morayta Enterprises

Date Particulars Debits Credits Balance
July 1 Shipped 100 units @144 14,440 14,400 dr
1 Freight cost 1,1650 15,560 dr
31 Charges by consignee:
Delivery expense 450 16,010 dr
Commissions @ 20% of sales 3,405 19,416 dr
31 Sale of 65 units at 262 17,030 2,386 dr
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The consignor debited the consignment- out account for all cost relating to the consignment and credited the
consignment- out account for all costs relating to the consignment and credited the consignment- out account for the
selling price of units sold by the consignee.
Question:
The amount remitted by the consignee on July 31 to the consignor is?
Suggested Answer:
Sales 17,030
Delivery Expense 450
Commission Expense 3,406 3,856
Net Remittance 13,174
SAMPLE PROBLEM NO. 5 – Long term Construction Contract

Grand Construction began operations in 2018. Construction activities for the year are shown below. All contracts are
with differ customers, and any work remaining at December 31, 2018 is expected to be completed in 2019. Grand uses
the cost to cost percentage of completion in accounting for its projects,
Project Contract Price Billings to date Collections to Actual cost to Additional cost
date date to Complete
One 560,000 360,000 340,000 450,000 130,000
Two 670,000 220,000 210,000 126,000 504,000
Three 520,000 500,000 440,000 330,000 0
Totals 1,750,000 1,080,000 990,000 906,000 643,000
Question:
Calculate the amount of inventory recognized as a current asset in the 2018 balance sheet.
Suggested Answer:
Project CIP PB NET
1 450,000-20,000 430,000 360,000 70,000 asset
2 126,000+ 8,000 134,000 220,000 86,000 Liabilities
3 Completed Contract
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1|P a g e

2. Primary Substantive Procedures

3. Other Substantive Procedures

General Guidelines for Good Handling of Cash

PRIMARY SUBSTANTIVE PROCEDURES

OTHER SUBSTANTIVE PROCEDURES

1. Surprise cash count

2. Obtain analysis of cash balance & reconcile it in the ledger

3. Review bank statements and bank replies to confirmation letters

SITUATIONAL PROBLEM NO. 1 – ABC Co. (Lapping) .

SITUATIONAL PROBLEM NO. 2 – Joey (Missing Petty Cash) )

SITUATIONAL PROBLEM NO. 3 – Kitchens Inc. (Kiting) .

SITUATIONAL PROBLEM NO. 4 – Truth Inc. (Falsification of Accounts) .

PRACTICAL PROBLEM NO. 1 – Cordial Company .

In the process of your audit, you gathered the following:

PRACTICAL PROBLEM NO. 1 – Wiles’ Inc .

Wiles’ cash account

Balance per books Php8,315.00

PRACTICAL PROBLEM NO. 3 – Posh Inc. .

Balance per books, October 31 Php41,847.85

a. Deposits in transit: #56 (P2,000 + 190,000 -188,500) Php3,500.00

b. Account Receivable, NSF check 200

PRACTICAL PROBLEM NO. 5 – October Company .

Balance per bank statement Php21,500.00

December 31, 1998

Balance per bank statement Php135,000.00

Total checks Php65,200

Corrected book balances 20,200 192,000 91,800 120,400

4.) Shortage as of December 31 \ Php 33,000

Cash receipts per ledger (₱198,200 – ₱ 20,200) Php 178,000

Cash disbursements per ledger (₱ 198,200 – 102,400) Php 95,800

PRACTICAL PROBLEM NO. 6 – Desole Company .

 On the company’s records the cash balance is ₱173,500.

The cashier made the following reconciliation:

Add: Undeposited collections (per

2.) Concealment of shortage:

2. Primary Substantive Procedures

3. Other Substantive Procedures

PRIMARY SUBSTANTIVE PROCEDURES

3. Evaluating the Adequacy of the Allowance for Doubtful Accounts

4. Expected Credit Losses

Date Particulars Debit Credit

Date Particulars Debit Credit

Date Particulars Debit Credit

Stage 2: Significant Deterioration

Date Particulars Debit Credit

Date Particulars Debit Credit

Computation of Impairment Loss

Stage 3: Credit Impaired

Computation of Impairment Loss

5. Accounts Receivable and Sales Cutoff

6. Investigate any transactions with or related party receivables.

7. Analyzing credit balances and unusual items.

8. Ascertaining whether any receivables have been pledged or assigned.

9. Performing analytical procedures.

OTHER SUBSTANTIVE PROCEDURES

 Bill and Hold Transaction.

SITUATIONAL PROBLEM NO. 1 – Palisades Inc. .

SITUATIONAL PROBLEM NO. 2 – Lakeside Company .