APPLIED AUDITING

CHAPTER 4
AUDIT OF INVESTMENTS

Objective
1. Solving Audit of Inventories Problems
2. Theory of Audit of Inventories

PROBLEM NO. 1

The following transactions of the Angat Company were completed during the
year 2006:

Jan. 2 Purchased 20,000 shares of Bulacan Auto Co. for P40

per share plus brokerage costs of P4,500. These
shares were classified as trading securities.

Feb. 1 Purchased 20,000 shares of Malolos Company

common stock at P125 per share plus brokerage fees
of P19,000. Angat classifies this stock as and
available-for-sale security.

Apr. 1 Purchased P2,000,000 of RP Treasury 7% bonds,

paying 102.5 plus accrued interest of P35,000. In
addition, the company paid brokerage fees of P18,000.
Angat classified these bonds as a trading security.

Jul. 1 Received semiannual interest on the RP Treasury

Bonds.

Aug. 1 Sold P500,000 of RP Treasury 7% bonds at 103 plus

accrued interest.

Oct. 1 Sold 3,000 shares of Malolos at P132 per share.

APPLIED AUDITING

The market values of the stocks and bonds on December 31, 2006, are as
follows:

Bulacan Auto Co. P45 per share

Malolos Company P130 per
share
RP Treasury 7% bonds 102

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Gain or loss on sale of P500,000 RP Treasury Bonds on August 1, 2006

a. P15,000 gain c. P2,000 loss
b. P 2,500 gain d. P7,500 loss

2. Gain or loss on sale of 3,000 Malolos shares on October 1, 2006

a. P18,150 loss c. P 2,000 gain
b. P18,150 gain d. P21,000 gain

3. What amount of unrealized gain should be shown as component of income

in 2006?
a. P92,500 c. P74,500
b. P97,000 d. P80,000

4. What amount of unrealized gain should be shown as component of equity

as of December 31, 2006?
a. P68,850 c. P66,000
b. P85,000 d. P 0

Suggested Solution:

Question No. 1

Sales proceeds (P500,000 x 1.03) P515,000

Less cost of RP Treasury bonds sold (P500,000 x 512,500
1.025)*
Gain on sale of P500,000 RP Treasury Bonds P 2,500

* PAS 39 par. 43 states that when a financial asset or financial liability is

recognized initially, an entity shall measure it at its fair value plus, in the
case of a financial asset or financial liability not at fair value through profit
or loss, transaction costs that are directly attributable to the acquisition or
issue of financial asset or financial liability. Therefore, the transaction costs
(e.g. brokerage fees) should be expensed for trading securities.

Question No. 2
APPLIED AUDITING

Sales proceeds (3,000 shares x P396,000

P132)
Less cost of shares sold
{[(20,000 x P125) + P19,000] x 377,850
3/20}
Gain on sale of 3,000 Malolos P 18,150
shares

Question No. 3

Cost of Bulacan Auto Co. shares (20,000 x P 800,000

P40)
Cost of RP Treasury 7% bonds (P2,000,000 x 2,050,000
1.025)
Cost of P500,000 RP Treasury bonds sold (see ( 512,500)
no. 1)
Trading securities, 12/31/06 before 2,337,500
mark-to-market
Fair value of trading securities, 12/31/06 (see 2,430,000
below)
Unrealized gain on TS to be reported on the IS P 92,500

Bulacan Auto Co. (20,000 x P45) P 900,000

RP Treasury 7% bonds (P1,500,000 x 1.02) 1,530,200
Fair value of trading securities, 12/31/06 P2,430,000

Question No. 4

Cost of Malolos Company shares

[(20,000 x P125) + P19,000] P2,519,000
Cost of 3,000 shares sold (see no. 2) (377,850)
AFS, 12/31/06 before mark-to-market 2,141,150
Fair value of AFS, 12/31/06 [(20,000 - 3,000) x 2,210,000
P130]
Unrealized gain-AFS, 12/31/06 to be reported P 68,850
under SHE

Answers: 1) B; 2) B; 3) A; 4) A

PROBLEM NO. 2

You were engaged by Balagtas Company to audit its financial statements for
the year 2006. During the course of your audit, you noted that the following
trading securities were properly reported as current assets at December 31,
2005:
APPLIED AUDITING

Cost Market
France Corporation, 5,000 shares,
convertible preferred shares P 450,000 P 487,500
Ces, Inc., 30,000 shares of common 675,000 742,500
stock
Coo Co., 10,000 shares of common 618,750 450,000
stock
P1,743,750 P1,680,000

The following sale and conversion transactions transpired during 2006:

Mar. 1 Sold 12,500 shares of Ces for P33.75 per share.

April 1 Sold 2,500 shares of Coo for P45 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 2006 dividend information pertains to stocks owned by Balagtas:

Jan. 2 Coo issued a 10% stock dividend when the market

price of Coo’s common stock was P49.50 per
share.

March 31 France paid dividends of P2.50 per share on its

and Sept. preferred stock, to stockholders of record on
30 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:

12/31/2006 12/31/2005
France Corp., 92.25 97.50
preferred
France Corp., 42.75 38.25
common
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.
APPLIED AUDITING

QUESTIONS:

Based on the above and the result of your audit, you are to provide the
answers to the following:

1. How much is the gain on sale of 12,500 Ces shares?

a. P112,500 c. P140,625
b. P281,250 d. P 0

2. How much is the gain or loss on sale of 2,500 Coo shares?

a. P28,125 gain c. P28,125 loss
b. P10,227 gain d. P 0

3. How much is the gain or loss on conversion of 2,500 France preferred

stock into 15,000 common stock?
a. P 28,125 loss c. P46,875 loss
b. P129,375 gain d. P 0

4. How much is the total dividend income for the year 2006?
a. P 64,375 c. P 51,875
b. P101,375 d. P364,375

5. How much should be reported as unrealized gain on trading securities in

the company’s income statement for the year 2006?
a. P 4,500 c. P59,250
b. P67,773 d. P 0

Suggested Solution:

Question No. 1

Sales proceeds (12,500 shares x P33.75) P421,875

Less CV of Ces shares sold (12.5/30 x 309,375
P742,500)
Gain on sale of 12,500 Ces shares P112,500

Question No. 2

Sales proceeds (2,500 shares x P45) P112,500

Less CV of Coo shares sold (P450,000 x 102,273
2,500/11,000*)
Gain on sale of 2,500 Coo shares P 10,227

* total number of shares after 10% stock dividends (10,000 x 1.1)

Question No. 3

Fair value of preferred stock (2,500 shares x P196,875

P78.75)
Less CV of shares converted (P487,500 x 2.5/5) 243,750
Loss on conversion of 2,500 France preferred P 46,875
APPLIED AUDITING

shares

Question No. 4

From France (5,000 shares x P2.50 x 2) P25,000

From Ces [(30,000 - 12,500) x P2.25) 39,375
Total dividend income in 2006 P64,375

Question No. 5

Trading securities, 1/1/06 P1,680,000

CV of Ces shares sold (see no. 1) (309,375)
CV of Coo shares sold (see no. 2) (102,273)
CV of France preferred shares converted (see (243,750)
no. 3)
Cost of 7,500 France common shares received 196,875
(see no. 3)
Trading securities, 12/31/06 before 1,221,477
mark-to-market
Fair value of trading securities, 12/31/06 (see 1,289,250
below)
Unrealized gain on trading securities P 67,773

France Corp., preferred [(5,000 - 2,500) x P 230,625

P92.25]
France Corp. – Common (7,500 x P42.75) 320,625
Ces, Inc., common [(30,000 - 12,500) x 393,750
P22.50]
Coo Co., common {[(10,000 x 1.1) - 2,500] x 344,250
P40.50}
Fair value of trading securities, 12/31/06 P1,289,250

Answers: 1) A; 2) B; 3) C; 4) A; 5) B

PROBLEM NO. 3
You were able to obtain the following ledger details of Trading Securities in
connection with your audit of the Bocaue Corporation for the year ended
December 31, 2006:

Particulars Date Ref. DR CR

Purchase of GOOD Co. – 1-14 CV P
4,000 shares 960,000

Purchase of LUCK Co. –

4,800 shares 2-20 CV 1,200,000
APPLIED AUDITING

Sale of LUCK Co. – 1,600 3-01 CR 360,000

shares

Receipt of GOOD Stock

Dividend – Offsetting Credit
to retained earnings 5-31 JV 88,000

Sale of GOOD Stocks –

3,200 shares 8-15 CR 784,000

Sale of GOOD Stocks –

800 shares 10-1 CR 184,000

From the Philippine Stock Exchange, the GOOD dividends were analyzed as
follows:

Kind Declared Record Payment Rate

Cash 01-02 01-15 01-31 P20/share
Stock 05-02 05-15 05-31 10%
Cash 08-01 08-30 09-15 P30/share

At December 31, 2006, GOOD and LUCK shares were selling at P210 and
P240 per share, respectively.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Gain or loss on sale of 1,600 LUCK shares on March 1, 2006

a. P360,000 gain c. P40,000 loss
b. P200,000 loss d. P40,000 gain

2. Gain on sale of 3,200 GOOD shares on August 15, 2006

a. P 48,000 c. P16,000
b. P144,000 d. P 0

3. Gain or loss on sale of 800 GOOD shares on October 1, 2006

a. P 8,000 gain c. P 8,000 loss
b. P24,000 loss d. P24,000 gain

4. Dividend income for the year 2006

a. P132,000 c. P212,000
b. P300,000 d. P 0

5. Carrying value of Trading Securities as of December 31, 2006

a. P768,000 c. P880,000
b. P852,000 d. P768,000

Suggested Solution:
APPLIED AUDITING

Question No. 1

Sales proceeds P360,000

Less CV of shares sold (P1,200,000 x 400,000
1,600/4,800)
Loss on sale of 1,600 Luck shares on 3/1/06 P 40,000

Question No. 2

Total proceeds P784,000

Less dividends sold (3,200 shares x P30) 96,000
Sales proceeds 688,000
Less CV of investment sold
(P880,000* x 3,200/4,400**) 640,000
Gain on sale of 3,200 Good shares on P 48,000
9/15/06

Computation of adjusted cost of Good Co. shares

Total cash paid P960,000

Less purchased dividend (4,000 x P20) 80,000
Adjusted cost P880,000 *

**After 10% stock dividend

Question No. 3

Sales proceeds P184,000

Less CV of investment sold (P880,000 x 160,000
800/4,400)
Gain on sale of 800 Good shares on 10/1/06 P 24,000

Question No. 4

Dividend income - Declared Aug. 1 (4,400 shares x P30) P132,000

Question No. 5

Good Co. [(4,000 x 1.1) - 3,200 - 800] = 400 P 84,000

x P210
Luck Co. (4,800 - 1,600) = 3,200 x P240 768,000
Carrying value of trading securities, P852,000
12/31/06

Answers: 1) C; 2) A; 3) D; 4) A, 5) B

PROBLEM NO. 4
APPLIED AUDITING

In connection with your audit of the financial statements of the Guiguinto

Company for the year 2006, the following Available for Sale Securities and
Dividend Income accounts were presented to you:

Available for Sale Securities

Date Description Ref. Debit Credit
01/08 Purchased 20,000 shares
common, par value
P50, BUSTOS Co. VR-69 780,000
03/30 10,000 shares BUSTOS
Co. CJ-30 500,000
04/03 received as stock CR-44 250,000
12/02 dividend CR-65 240,000
Sold 10,000 shares @
P25
Sold 4,000 shares @ P60

Dividend Income
Date Description Ref. Debit Credit
03/30 Stock dividend SJ-8 500,000
08/30 BUSTOS Company CR-52 100,000
common

The following information was obtained during your examination:

1. From independent sources, you determine the following dividend

information:

Type of Date Date of Date of

Dividend Declared Record Payment Rate
Stock 02/14/2006 02/28/2006 03/30/2006 50%
Cash 08/01/2006 08/15/2006 08/30/2006 P5/share
Cash 12/01/2006 12/15/2006 01/02/2007 20%

2. Closing market quotation as at December 31, 2006:

Bid Asked
BUSTOS Company common 13-3/4 16-1/2

QUESTIONS:

Based on the above and the result of your audit, answer the following:

1. How much is the gain or loss on the April 3, 2006 sale?

a. P10,000 loss c. P140,000 loss
b. P10,000 gain d. P 0

2. How much is the gain on the December 2, 2006 sale?

a. P136,000 c. P84,000
b. P 96,000 d. P 0
APPLIED AUDITING

3. How much is the total dividend income for the year 2006?
a. P600,000 c. P100,000
b. P800,000 d. P300,000

4. How much is the adjusted balance of Available for Sale Securities as of

December 31, 2006?
a. P290,000 c. P220,000
b. P264,000 d. P416,000

5. How much is the Unrealized Loss on AFS as of December 31, 2006?

a. P196,000 c. P152,000
b. P 70,000 d. P 0

Suggested Solution:

Question No. 1

Sales proceeds (10,000 shares x P25) P250,000

Less CV of investment sold (P780,000 x 260,000
10/30*)
Loss on sale of AFS on 4/3/06 P 10,000

*After 50% stock dividend

Question No. 2

Total proceeds (4,000 shares x P60) P240,000

Less dividends sold (4,000 shares x P50 x 40,000
20%)
Net sales proceeds 200,000
Less CV of investment sold (P780,000 x 104,000
4/30)
Gain on sale of AFS on 12/2/06 P 96,000

Question No. 3

Cash dividends declared, 8/1/2006 P100,000

(20,000 shares x P5)
Cash dividends declared, 12/1/2006
(20,000 shares x P50 x 20%) 200,000
Total dividend income P300,000

Question No. 4

Shares purchased, 1/08 20,000

Shares received as stock dividend 10,000
Sold, 4/3 (10,000)
Sold, 12/2 (4,000)
Balance, 12/31/06 16,000
APPLIED AUDITING

Multiply by market value/share, 12/31/06 13.75

Carrying value of AFS, 12/31/06 P220,000

Note: Application guidance par. 72 of PAS 39 states that the appropriate

market price for an asset held or liability to be issued is usually the current
bid price and, for an asset to be acquired or liability held, the asking price.

Question No. 5

Acquisition cost P780,000

CV of 10,000 shares sold, 4/3 (see no. 1) (260,000)
CV of 4,000 shares sold, 12/2 (see no. 2) (104,000)
AFS, 12/31/06 before mark-to-market 416,000
Fair value of AFS, 12/31/06 220,000
Unrealized loss on AFS, 12/31/06 P196,000

Answers: 1) A; 2) B; 3) D; 4) C, 5) A

PROBLEM NO. 5

The Marilao Company has the following transactions in the stocks of the Sta.
Maria Corp.

a) On January 2, 1999, Marilao purchased 4,000 shares of P100 par value

common stock at P110 per share.

b) The Sta. Maria Corp. was expanding and on March 2, 2000, it issued stock
rights to its stockholders. The holder needs four rights to purchase one
share of common stock at par. The market value of the stock on that date
was P140 per share. There was no quoted price for the rights. No journal
entry was made to record the receipt of the rights.

c) On April 2, 2000, Marilao exercised all its stock rights. The Investment in
Stock account was charged for the amount paid.

d) Robinson, Marilao’s accountant, felt that the cash paid for the new shares
was merely an assessment since Marilao’s proportionate share in Sta.
Maria was not changed. Hence, he credited all dividends (5% in December
of each year) to the Investment in Stock account until the debit was fully
offset.

e) Marilao received a 50% stock dividend from Sta. Maria in December 2004.
Because the shares received were expected to be sold, the company’s
president instructed Robinson not to make any entry for this dividend. The
company did sell the dividend shares in January 2005 for P150 per share.
The proceeds from the sale were credited to income.

f) In December 2005, Sta. Maria’ stocks were split on a two-for-one basis and
the new shares were issued as no par shares. Marilao found that each
APPLIED AUDITING

new share was worth P10 more than the P110 per share original
acquisition cost. For this reason, Marilao decided to debit the Investment in
Stock account with the additional shares received at P110 per share and
credited revenue for it.

g) In August 2006, Marilao sold one half (½) of its holdings in Sta. Maria at
P120 per share. The proceeds were credited to the Investment in Stock
account.

Marilao uses the average method in recording the sale of its investment in
stock.

QUESTIONS:

1. The cost of investment to be allocated to stock rights received on March 2,

2000 is
a. P 0 c. P31,429
b. P29,333 d. P25,143

2. The unadjusted balance of Investment in Sta. Maria stock on December 31,

2006 is
a. P940,000 c. P390,000
b. P490,000 d. P430,000

3. The adjusted balance of Investment in Sta. Maria stock on December 31,

2006 is
a. P135,000 c. P180,000
b. P360,000 d. P270,000

4. The gain on the sale of stock dividend received in December 2004 is

a. P100,000 c. P 80,000
b. P105,000 d. P195,000

5. The gain on sale of the shares sold in August 2006 is

a. P240,000 c. P120,000
b. P420,000 d. P870,000

Suggested Solution:

Question No. 1

Cost allocated to stock rights (P10*/P150 x P440,000) P29,333

Since the MV of rights is not available we must compute for the theoretical
value of the stock rights. Since the market value of the stock given is on
the date of issuance of the stock rights, the market value is considered
“ex-rights”.

Theoretical value of stock rights = MV of stock ex-rights – subs. price

Number of rights to purchase 1 share
APPLIED AUDITING

= (P 140 - P100)/4

= P10*

Question No. 2

Debits to Investment account:

Purchase, 1/2/99 (4,000 shares x P440,000
P110)
Exercise of rights, 4/2/00 (4,000/4 x 100,000
P100)
Stock split, 12/2005 (5,000 x P110) 550,000 P1,090,000
Less credits to Investment account:
Dividends received, 2000-2003
(5,000 x P100 x 5% x 4) 100,000
Sale, 8/2006 (5,000 shares x P120) 600,000 700,000
Balance, 12/31/06 per books P 390,000

Question No. 3

Cost/
Shares share Total cost
Purchase, 1/2/1999 4,000 P110 P440,000
Receipt of stock rights, 3/2/2000 (29,333)
Balance 4,000 103 410,667
Exercise of rights, 4/2/2000 (see 1,000 129 129,333
below)
Balance 5,000 108 540,000
50% stock dividend, 12/2004 2,500
Balance 7,500 72 540,000
Sale of stock dividend, 1/2005 (2,500) 72 (180,000)
Balance 5,000 72 360,000
Stock split, 12/2005 5,000
Balance 10,000 36 360,000
Sale, 8/2006 (5,000) 36 (180,000)
Adjusted balance, 12/31/06 5,000 36 P180,000

Cash paid (4,000/5 x P100) P 80,000

Cost of stock rights 29,333
Total cost P129,333

Question No. 4

Sales proceeds (2,500 shares x P150) P375,000

Less cost of investment sold (see no. 3) 180,000
Gain on sale of stock dividend received P195,000
APPLIED AUDITING

Question No. 5

Sales proceeds (5,000 shares x P120) P600,000

Less cost of investment sold (see no. 3) 180,000
Gain on sale of investment in 8/2006 P420,000
Answers: 1) B; 2) C; 3) C; 4) D, 5) B

PROBLEM NO. 6

Meycauayan Inc. acquired 50,000 shares of AAA stock for P5 per share and
125,000 shares of BBB stock for P10 per share on January 2, 2005. Both AAA
Inc. and BBB Corp. have 500,000 shares of no-par common stock outstanding.
Both securities are being held as long term investments. Changes in retained
earnings for AAA and BBB for 2005 and 2006 are as follows:

AAA, Inc. BBB Corp.

Retained earnings (deficit), 1/1/05 P1,000,000 (P175,000)
Cash dividends, 2005 (125,000) -
Net income, 2005 200,000 325,000
Retained earnings, December 31, 1,075,000 150,000
2005
Cash dividends, 2006 (150,000) (50,000)
Net income, 2006 300,000 125,000
Retained earnings, December 31, P1,225,000 P 225,000
2006

Market value of stock: 12/31/05 P7.00 P12.00

12/31/06 6.50 15.00

QUESTIONS:

Based on the above and the result of your audit, answer the following:

1. The income from investment in AAA, Inc. in 2006 is

a. P15,000 c. P12,500
b. P 1,000 d. P 0

2. The income from investment in BBB, Inc. in 2005 is

a. P31,250 c. P2,500
b. P81,250 d. P 0

3. The carrying value of Investment in AAA, Inc. as December 31, 2006 is

a. P250,000 c. P325,000
b. P350,000 d. P252,500

4. The carrying value of Investment in BBB, Inc. as December 31, 2006 is

a. P1,250,000 c. P1,875,000
b. P1,268,750 d. P1,350,000
APPLIED AUDITING

5. How much is the unrealized gain or loss that will be included as component
of equity as of December 31, 2006?
a. P75,000 gain c. P25,000 gain
b. P25,000 lossd. P 0

Suggested Solution:

Question No. 1

Meycauayan, Inc. owns 10% (50,000/500,000) of AAA, Inc. stock; therefore,

the cost method is used and the dividend is computed as follows:

Dividends paid by AAA, Inc. in 2006 P150,000

Multiply by % ownership 10%
Income from investment in AAA, Inc. in P 15,000
2006

Question No. 2

Meycauayan, Inc. owns 25% (125,000/500,000) of BBB Corp. stock;

therefore, the equity method is used to record the income earned.

AAA, Inc. net income in 2005 P325,000

Multiply by % ownership 25%
Income from investment in BBB Corp. in P 81,250
2005

Question No. 3

Investment in AAA, Inc. stock will be classified as available-for-sale

securities since the shares are held as long term investment and there is
reliable fair value. Therefore, the carrying value as of 12/31/06 is
P325,000 (50,000 shares x P6.50).

Question No. 4

Acquisition cost (125,000 shares x P10) P1,250,000

Share in net income for 2005 (P325,000 x 81,250
25%)
Carrying value, 12/31/05 1,331,250
Dividends received in 2006 (P50,000 x (12,500)
25%)
Share in net income for 2006 (P125,000 x 31,250
25%)
Carrying value, 12/31/06 P1,350,000

Question No. 5

Fair value, 12/31/06 (50,000 shares x P 325,000

P6.50)
APPLIED AUDITING

Acquisition cost (50,000 shares x P5) 250,000

Unrealized gain, 12/31/06 P 75,000

Answers: 1) A; 2) B; 3) C; 4) D, 5) A

PROBLEM NO. 7

On January 2, 2004, Norzagaray Company acquired 20% of the 400,000

shares of outstanding common stock of Imaw Corporation for P30 per share.
The purchase price was equal to Imaw’s underlying book value. Norzagaray
plans to hold this stock to influence the activities of Imaw.

The following data are applicable for 2004 and 2005:

2004 2005
Imaw dividends (paid Oct. 31) P 40,000 P 48,000
Imaw earnings 140,000 160,000
Imaw stock market price at 32 31
year-end

On January 2, 2006, Norzagaray Company sold 20,000 shares of Imaw stock

for P31 per share. During 2006, Imaw reported net income of P120,000, and
on October 31, 2006, Imaw paid dividends of P20,000. At December 31, 2006,
after a significant stock decline, which is expected to be temporary, Imaw’s
stock was selling for P22 per share. After selling the 20,000 shares,
Norzagaray does not expect to exercise significant influence over Imaw, and
the shares are classified as available for sale.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Carrying value of Investment in Imaw as of December 31, 2004

a. P12,020,000 c. P2,420,000
b. P 2,500,000 d. P2,388,000

2. Carrying value of Investment in Imaw as of December 31, 2005

a. P2,442,400 c. P12,042,400
b. P2,612,000 d. P 2,372,000

3. Gain or loss on sale of Investment in Imaw on January 2, 2006

a. P2,390,600 loss c. P33,000 loss
b. P 9,400 gain d. P27,000 gain

4. The income from investment in BBB, Inc. in 2005 is

a. P 3,000 c. P4,000
b. P24,000 d. P 0
APPLIED AUDITING

5. Net unrealized loss on available for sale securities as of December 31,

2006
a. P671,800 c. P639,000
b. P511,800 d. P459,000

Suggested Solution:

Question No. 1

Acquisition cost (400,000 x 20% x P30) P2,400,000

Dividends received(P40,000 x 20%) (8,000)
Investment income (P140,000 x 20%) 28,000
Carrying value, 12/31/04 P2,420,000

Question No. 2

Carrying value, 12/31/04 (see no. 1) P2,420,000

Dividends received (P48,000 x 20%) (9,600)
Investment income (P160,000 x 20%) 32,000
Carrying value, 12/31/05 P2,442,400

Question No. 3

Sales proceeds (20,000 x P31) P620,000

Less carrying value of investment sold
(P2,442,400 x 20/80) 610,600
Gain on sale of investment P 9,400

Question No. 4

Dividend income (P20,000 x 15%*) P3,000

* [20% - (20,000/400,000 x 100%)]

Question No. 5

Carrying value, 12/31/05 P2,442,400

Less carrying value of investment sold 610,600
Carrying value, 12/31/06 - before 1,831,800
reclassification
Fair value of AFS, 12/31/06 [(80,000 - 20,000) 1,320,000
x P22]
Unrealized loss on AFS P 511,800

Answers: 1) C; 2) A; 3) B; 4) A, 5) B

PROBLEM NO. 8
APPLIED AUDITING

You were able to gather the following in connection with your audit of Obando,
Inc. On December 31, 2005, Obando reported the following available for sale
securities:

Unrealize
Cost Market d loss
ERAP Corp., 10,000
shares of common
stock P 250,000 P 220,000 P 30,000
(a 1% interest)
GMA Corp., 20,000
shares of common
stock 320,000 300,000 20,000
(a 2% interest)
FVR Corp., 50,000
shares of common
stock 1,400,000 1,350,000 50,000
(a 10% interest)
Total P1,970,000 P1,870,000 P100,000

Additional information:

 On April 1, 2006, ERAP issued 10% stock dividend when the market price
of its stock was P24 per share.
 On September 15, 2006, ERAP paid cash dividend of P0.75 per share.

 On August 30, 2006, GMA issued to all shareholders, stock rights on the
basis of one right per share. Market prices at date of issue were P13.50
per share of stock and P1.50 per right. Obando sold all rights on
December 1, 2006 for net proceeds of P37,600.

 On July 1, 2006, Obando paid P3,040,000 for 100,000 additional shares of

FVR Corp.’s common stock which represented a 20% investment in FVR.
The fair value of all of FVR’s identifiable assets net of liabilities was equal
to their carrying amount of P12,700,000. As a result of this transaction,
Obando owns 30% of FVR and can exercise significant influence over
FVR’s operating and financial policies.

 Obando’s initial 10% interest of 50,000 shares of FVR’s common stock was
acquired on January 2, 2005 for P1,400,000. At that date, the net assets of
FVR totaled P11,600,000 and the fair values of FVR‘s identifiable assets
net liabilities were equal to their carrying amount.

 Market prices per share of the securities which are all listed in the
Philippine Stock Exchange, are as follows:

12/31/2006 12/31/2005
APPLIED AUDITING

ERAP Corp. – common P23 P22

GMA Corp. – common 14 15
FVR Corp. – common 31 27

 FVR reported net income and paid dividends of:

Dividend
Net per share
income
Year ended December 31, 2005 P700,000 None
Six months ended June 30, 2006 400,000 None
Six months ended December 31,
2006 (dividend was paid on 740,000 P1.30
10/1/2006)

 There were no other intercompany transactions between Obando and FVR.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Net unrealized gain or loss on available for sale securities as of December

31, 2006
a. P95,000 gain c. P 5,000 loss
b. P37,000 loss d. P55,000 loss

2. Net adjustment to Retained Earnings as of January 1, 2006 as a result of

the purchase of additional shares of stock of FVR Corp.
a. P 70,000 c. P58,000
b. P210,000 d. P 0

3. Net investment income from FVR Corp. for year ended December 31, 2006
a. P237,500 c. P262,000
b. P225,000 d. P305,000

4. Carrying amount of Investment in FVR Corp. as of December 31, 2006

a. P4,674,500 c. P4,577,000
b. P4,677,000 d. P4,540,500

5. Gain on sale of stock rights on December 1, 2006

a. P 0 c. P7,600
b. P2,050 d. P5,600

Suggested Solution:

Question No. 1

Available-for-sale securities, P 1,870,000

APPLIED AUDITING

1/1/06
Receipt of stock rights from GMA,
8/30 (P300,000 x 1.5/15) (30,000)
Reclassification of Investment in (1,350,000)
FVR
AFS, 12/31/06 before 490,000
mark-to-market
Fair value of AFS, 12/31/06:
GMA [(10,000 x 1.1) x 23] P253,000
ERAP (20,000 x 14) 280,000 533,000
Decrease in unrealized loss on 43,000
AFS
Unrealized loss on AFS, 12/31/05
(P100,000 - P2,000 - P50,000)
(see note below) 48,000
Unrealized loss, 12/31/06 - as P 5,000
adjusted

Note: Alternatively, the unrealized loss on AFS can be computed by

comparing the total fair value and total cost of AFS as of December 31,
2006. Incidentally, the journal entries to record the receipt of stock rights
and reclassification of the investment in FVR follow:

Stock rights P 32,000

Available for sale securities (P300,000 x 1.5/15) P30,000
Unrealized loss on AFS (P20,000 x 1.5/15) 2,000

Investment in associate P1,400,000

Available for sale securities P1,350,000
Unrealized loss on AFS 50,000

Questions No. 2 to 4

Reclassification of investment in FVR (see no. 1) P1,400,000

Retroactive adjustment
(cost to equity method):
Share in NI for 2005 (P700,000 x 70,000 (2)
10%)
Adjusted balance, 1/1/06 1,470,000
Cost of additional 100,000 shares 3,040,000
Net investment income for 2006:
Share in NI for six months ended
6/30 (P400,000 x 10%) P40,000
Share in NI for six months ended
12/31 [P740,000 x (10%+20%)] 222,000 262,000 (3)
Dividends received
[(50,000 shares + 100,000 shares) (195,000)
x 1.3]
Carrying value of investment in FVR, 12/31/06 P 4,577,000 (4)
APPLIED AUDITING

Note: The excess of cost over the book value of net assets acquired will be
attributed to Goodwill. Therefore, the excess will not affect the investment
income and the carrying value of the investment since Goodwill is not
amortized.

Question No. 5

Sales proceeds P37,600

Less cost of stock rights (see no. 32,000
1)
Gain on sale of stock rights P 5,600

Answers: 1) C; 2) A; 3) C; 4) C, 5) D

PROBLEM NO. 9

Paombong Corporation purchased P200,000 8% bonds for P184,557 on

January 1, 2004. Paombong classified the bonds as available for sale. The
bonds were purchased to yield 10% interest. Interest is payable semiannually
on July 1 and January 1. The bonds mature on January 1, 2009. Paombong
uses the effective interest method to amortize premium or discount. On
January 2, 2006, Paombong sold the bonds for P190,000 after receiving
interest to meet its liquidity needs.

The market values of the bonds are as follows:

December 31, 2004 P190,449

December 31, 2005 186,363

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Interest income for the year 2004

a. P14,869 c. P18,517
b. P16,000 d. P18,456

2. Unrealized gain on AFS as of December 31, 2004

a. P3,436 c. P5,892
b. P3,375 d. P 0

3. Interest income for the year 2005

a. P18,775 c. P16,000
b. P15,272 d. P18,701

4. Unrealized gain or loss on AFS as of December 31, 2005

a. P8,053 gain c. P3,351 gain
b. P3,486 loss d. P1,806 loss
APPLIED AUDITING

5. Realized gain or loss on sale of AFS on January 2, 2006

a. P6,861 loss c. P4,849 loss
b. P4,714 loss d. P9,416 gain

Suggested Solution:

Question No. 1

The following amortization schedule will be useful in computing for the

requirements:

Effective Nominal Discount Carrying

Date interest interest amortization value
01/01/04 P184,557
07/01/04 P9,228 P8,000 P1,228 185,785
12/31/04 9,289 8,000 1,289 187,074
07/01/05 9,354 8,000 1,354 188,428
12/31/05 9,421 8,000 1,421 189,849
07/01/06 9,492 8,000 1,492 191,341
12/31/06 9,567 8,000 1,567 192,908
07/01/07 9,645 8,000 1,645 194,553
12/31/07 9,728 8,000 1,728 196,281
07/01/08 9,814 8,000 1,814 198,095
12/31/08 9,905 8,000 1,905 200,000

1/1/04 to 6/30/04 (see amortization P 9,228

schedule)
7/1/04 to 12/31/04 (see amortization 9,289
schedule)
Total interest income for 2004 P18,517

Note: PAS 39 par. 55(b) states that a gain or loss on an available-for-sale

financial asset shall be recognized directly in equity, through the statement
of changes in equity, except for impairment losses and foreign exchange
gains and losses, until the financial asset is derecognized, at which time
the cumulative gain or loss previously recognized in equity shall be
recognized in profit or loss. However, interest calculated using effective
interest method shall be recognized in profit or loss.

Question No. 2

Fair value the bonds, 12/31/04 P190,449

Carrying value, 12/31/04 (see amortization 187,074
schedule)
Unrealized gain on AFS, 12/31/04 P 3,375

Question No. 3
APPLIED AUDITING

1/1/05 to 6/30/05 (see amortization P 9,354

schedule)
7/1/05 to 12/31/0 (see amortization 9,421
schedule)
Total interest income for 2005 P18,775

Question No. 4

Fair value the bonds, 12/31/05 P186,363

Carrying value, 12/31/05 (see amortization 189,849
schedule)
Unrealized loss on AFS, 12/31/05 (P 3,486)

Incidentally, the adjusting entry on 12/31/05 follows:

Unrealized gain on AFS P 3,375

Unrealized loss on AFS 3,486
Available for sale securities P6,861

Question No. 5

Sales proceeds P185,000

Unrealized loss on AFS ( 3,486)
Net 181,514
Carrying value, 12/31/05 (fair value) 186,363
Realized loss on sale of AFS (P 4,849)

Note: PAS 39 par. 26 states that on derecognition of a financial asset in its

entirety, the difference between (a) the carrying amount and (b) the sum of
the consideration received and any cumulative gain or loss recognized
directly in equity, shall be recognized in profit or loss. Incidentally, the
journal entry to record the sale is:

Cash P185,000
Realized loss on sale of AFS 4,849
Available for sale securities P186,363
Unrealized loss on AFS 3,486

Answers: 1) C; 2) B; 3) A; 4) B, 5) C

PROBLEM NO. 10

On May 1, 2003, Plaridel Corporation acquired P1,600,000 of J & B

Corporation 9% bonds at 97 plus accrued interest. Interest on bonds is
payable semiannually on March 1 and September 1, and bonds mature on
September 1, 2006. Plaridel intends to hold these bonds until they matured.
APPLIED AUDITING

Due to an isolated event that is beyond Plaridel’s control, is non-recurring and

could not have been reasonably anticipated by Plaridel, the company sold
bonds of P480,000 for 103 plus accrued interest on May 1, 2004.

On July 1, 2005, bonds of P640,000 were exchanged for 90,000 shares of J &
B Corporation, common, no par value, quoted on the market on this date at P8
per share. Interest was received on bonds to date of exchange.

On September 1, 2006, remaining bonds were redeemed and accrued interest

was received.

QUESTIONS:

Based on the above and the result of your audit, determine the following: (Use
the straight line amortization method)

1. Total interest income for 2003 is

a. P96,000 c. P105,600
b. P86,400 d. P106,800

2. The carrying value of the investment in bonds as of December 31, 2003 is

a. P1,561,600 c. P1,562,800
b. P1,540,000 d. P1,564,000

3. The gain on sale of the bonds on May 1, 2004 is

a. P 0 c. P 2,880
b. P4,320 d. P24,480

4. The gain on exchange the bonds on July 1, 2005 is

a. P 0 c. P57,920
b. P86,720 d. P73,280

5. Total cash received by the company on September 1, 2006 is

a. P501,600 c. P480,000
b. P523,200 d. P508,800

Suggested Solution:

Question No. 1

Nominal interest (P1,600,000 x 9% x 8/12) P 96,000

Discount amortization for 2003 (P48,000 x 9,600
8/40)
Total interest income for 2003 P105,600

Question No. 2

Carrying value, 5/1/03 (P1,600,000 x 97%) P1,552,000

Add discount amortization for 2003 (see no. 9,600
1)
APPLIED AUDITING

Carrying value, 12/31/03 P1,561,600

Question No. 3

Selling price (P480,000 x 1.03) P494,400

Less carrying value of bonds sold:
Face value P480,000
Less unamortized bond discount,
5/1/04 to 9/1/06 (P48,000 x 10,080 469,920
480/1,600 x 28/40)
Gain on sale of investment in bonds P 24,480

PAS 39 par. 52 states that whenever sales or reclassifications of more than

an insignificant amount of held-to-maturity investments do not meet any of
the conditions in par. 9, any remaining held-to-maturity investments shall be
reclassified as available for sale. Since the sale of the bonds on May 1, 2004
is due to an isolated event that is beyond Plaridel’s control, is non-recurring
and could not have been reasonably anticipated by Plaridel, the investment
is not required to be reclassified as available for sale.

Question No. 4

Fair value of stocks received (P90,000 x P720,000

P8)
Less carrying value of bonds
exchanged:
Face value P640,000
Less unamortized bond discount,
7/1/05 to 9/1/06 (P48,000 x 6,720 633,280
640/1,600 x 14/40)
Gain on exchange of bonds P 86,720

Question No. 5

Face value of remaining bonds

(P1,600,000 - P480,000 - P640,000) P480,000
Interest, 3/1/06 to 9/1/06 (P480,000 x 9% x 21,600
6/12)
Total cash received, 9/1/06 P501,600

Answers: 1) C; 2) A; 3) D; 4) B, 5) A

PROBLEM NO. 11

Select the best answer for each of the following:

APPLIED AUDITING

1. Which of the following is not a control that is designed to protect investment

securities?
a. Access to securities should be vested in more than one individual.
b. Securities should be properly controlled physically in order to prevent
unauthorized usage.
c. Securities should be registered in the name of the owner.
d. Custody over securities should be limited to individuals who have
recordkeeping responsibility over the securities.

2. Which of the following controls would a company most likely use to

safeguard investment securities when an independent trust agent is not
employed?
A. The chairman of the board verifies the investment securities, which are
kept in a bank safe deposit box, each year on the balance sheet date.
B. The investment committee of the board of directors periodically reviews
the investment decisions delegated to the treasurer.
C. Two company officials have joint control of investment securities, which
are kept in a bank safe deposit box.
D. The internal auditor and the controller independently trace all purchases
and sales of investment securities from the subsidiary ledgers to the
general ledger.

3. Which of the following controls would an entity most likely use to assist in
satisfying the completeness assertion related to long-term investments?
A. The controller compares the current market prices of recorded
investments with the brokers’ advices on file.
B. Senior management verifies that securities in the bank safe deposit box
are registered in the entity’s name.
C. The internal auditor compares the securities in the bank safe deposit
box with recorded investments.
D. The treasurer vouches the acquisition of securities by comparing
brokers’ advices with canceled checks.

4. Which of the following controls would an entity most likely use in

safeguarding against the loss of investment securities?
A. A designated member of the board of directors controls the securities in a
bank safe deposit box.
B. An independent trust company that has no direct contact with the
employees who have record-keeping responsibilities has possession of
securities.
C. The internal auditor verifies the investment securities in the entity’s safe
each year on the balance sheet date.
D. The independent auditor traces all purchases and sales of investment
securities through the subsidiary ledgers to the general ledger.

5.When negotiable securities are of considerable volume, planning by the

auditor is necessary to guard against
a.Substitution of securities already counted for other securities which should
be on hand but are not.
b.Substitution of authentic securities with counterfeit securities.
APPLIED AUDITING

c.Unauthorized negotiation of the securities before they are counted.

d.Unrecorded sales of securities after they are counted.

Answers: 1) D; 2) C; 3) C; 4) B, 5) A;

 To have Information about Introduction to Audit of Investment

https://youtu.be/0X-9PKSDo5U

 This video is all about Theory of Audit of Investments.

https://youtu.be/W3mqK1yIg_0

 This video is all about Solving Audit of Investments Problems

https://youtu.be/XWf21DDt2bU

Reference:
Compilation of lecture notes by
Dean Rene Boy R. Bacay , CPA, CrFA, CMC, MBA, FRIAcc