CPA REVIEW SCHOOL OF THE PHILIPPINES AP-9101-2

Manila
AUDITING PROBLEMS CPA Review

AUDIT OF SHAREHOLDERS’ EQUITY

PROBLEM NO. 1

The shareholders’ equity section of the Sy Co. showed the following data on December 31, 2021:

Ordinary share capital, P3 par, 900,000 shares authorized, 750,000 shares issued and
outstanding, P2,250,000
Share premium – Ordinary shares, P21,150,000
Share options outstanding, P450,000
Retained earnings, P1,440,000

The share options were granted to key executives and provided them the right to acquire 90,000
shares of ordinary shares at P35 per share. Each option has a fair value of P5 at the time the
options were granted.

The following transactions occurred during 2022:

1. On January 15, key executives exercised 13,500 options outstanding at December 31, 2021.
The market price per share was P44 at this time.

2. The company issued bonds of P6,000,000 at par on April 1, giving each P1,000 bond a
detachable warrant enabling the holder to purchase two shares of stock at P40 each for a 1-
year period. The bonds would sell at P996 per P1,000 bond without the warrant.

3. The company issued rights to stockholders (one right on each share, exercisable within a 30-
day period) on August 1 permitting holders to acquire one share at P40 with every 10 rights
submitted. All but 18,000 rights were exercised on August 31, and the additional stock was
issued.

4. All warrants issued in connection with the bonds on April 1 were exercised on October 1.

5. On December 1, the market price per share dropped to P33 and options came due. Because
the market price was below the option price, no remaining options were exercised.

6. Net income for 2022 was P751,500.

Questions:

Based on the above and the result of your audit, determine the following as of December 31,
2022:

1. Ordinary share capital

A. P2,331,900 B. P2,501,550 C. P2,550,150 D. P2,546,100

2. Share premium
A. P25,258,350 B. P22,566,600 C. P24,658,950 D. P25,208,400

3. Retained earnings
A. P1,741,500 B. P2,191,500 C. P2,574,000 D. P1,962,450

4. Total shareholders’ equity

A. P27,090,000 B. P30,000,000 C. P29,352,000 D. P29,946,000

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CPAR - MANILA AP-9101-2 – AUDIT OF SHAREHOLDERS’ EQUITY

PROBLEM NO. 2

The Retained Earnings account of Meow Moon, Inc. shows the following debits and credits for
the year 2022:

RETAINED EARNINGS
Balance
Date Debit Credit Debit Credit
Jan. 1 Balance 926,400
(a) Loss from flood 5,250 921,150
(b) Write-off of accounts receivable 52,500 868,650
(c) Property dividends distributed 140,000 728,650
(d) Loss on sale of machinery 48,300 680,350
(e) Officers’ compensation related to income
of prior periods – accrual omitted 325,500 354,850
(f) Gain on retirement of ordinary shares at
less than issue price 70,000 424,850
(g) Share premium from issuance of OS 129,500 554,350
(h) Share issuance costs
(related to letter g) 10,000 544,350
(i) Share subscription defaults 8,470 552,820
(j) Loss on retirement of ordinary shares
at more than issue price 25,900 526,920
(k) Gain on early retirement of bonds 15,050 541,970
(l) Gain on life insurance policy settlement 10,500 552,470
(m) Correction of a prior period error 50,050 602,520
(n) Effect of change in accounting principle
from weighted average to FIFO 100,000 502,520
(o) Cash dividends declared in 2021 and
distributed in 2022 25,000 477,520
(p) Gain on sale of treasury stock 20,000 497,520
(q) Proceeds from sale of donated stock 40,000 537,520
(r) Appraisal increase in land 250,000 787,520
(s) Appropriation for property acquisition 100,000 687,520

Questions:

1. Prepare adjusting journal entries to correct the Retained Earnings account.

2. Determine the correct amount of Retained Earnings account.

PROBLEM NO. 3

The year-end audit of the records of Welcome Sun Company disclosed a shortage in cash
amounting to P600,000. The treasurer had concealed the fraud by increasing inventories by
P300,000, land by P100,000 and accounts receivable by P200,000.

Faced with prosecution, the treasurer offered to surrender 6,000 Welcome Sun Company shares
owned by him. The board of directors accepted the offer, with the agreement that the treasurer
would pay any deficiency between the shortage and the book value of the shares, after adjusting
for the fraud. The corporation would in turn pay the excess, if any, of the book value over the
shortage.

As of December 31, 2022, there were 40,000 ordinary shares issued and outstanding with a par
value of P100; Retained earnings as of January 1, 2022 was P1,600,000 and net income from
2022 operations was P1,400,000.
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CPAR - MANILA AP-9101-2 – AUDIT OF SHAREHOLDERS’ EQUITY

Questions:
Considering the above information, answer the following:

1. What would be the book value per share for purposes of the agreement?
A. P175 B. P206 C. P150 D. None of these

2. How much would the company pay the treasurer, if any?

A. P450,000 B. P300,000 C. P636,000 D. None of these

PROBLEM NO. 4

In connection with the audit of GKNB Company’s financial statements for the year ended
December 31, 2022, your audit senior asked you to analyze the company’s shareholders’ equity
section and provide him with certain figures. The shareholders’ equity sections of the company’s
comparative balance sheets as of December 31, 2022 and 2021 are presented below:

12.31.2022 12.31.2021

12% Preference shares, P100 par P 330,000 P 270,000

Common stock, P10* par 1,642,400 1,598,400
Share premium – preference shares 53,600 36,800
Share premium – ordinary shares 257,200 235,200
Share premium – treasury shares 7,200 3,200
Retained earnings 1,884,800 1,585,840
Total stockholders’ equity P4,175,200 P3,729,440

*Par value after May 31, 2022 stock split.

GKNB had 65,000 ordinary shares outstanding as December 31, 2020.

The following stockholders’ equity transactions were recorded in 2021 and 2022:

2021
May 1 - Sold 9,000 ordinary shares for P24, par value P20.
July 1 - Sold 700 preference shares for P124, par value P100.
July 31 - Issued an 8% share dividend on ordinary shares. The market value of
ordinary shares was P30 per share.
Aug. 30 - Declared cash dividends of 12% on preference shares and P3 per share
on ordinary share.
Dec. 31 - Net income for the year amounted to P1,345,040

2022
Feb. 1 - Sold 2,200 ordinary shares for P30.
May 1 - Sold 600 preference shares for P128.
May 31 - Issued a 2-for-1 split of ordinary shares. The par value of the ordinary
shares was reduced to P10 per share.
Sep. 1 - Purchased 1,000 ordinary shares for P18 to be held as treasury shares.
Oct. 1 - Declared cash dividends of 12% on preference shares and P4 per share
on ordinary shares.
Nov. 1 - Sold 1,000 shares of treasury shares for P22.

Question:
Compute the basic earnings per share for the year 2021 and 2022.

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CPAR - MANILA AP-9101-2 – AUDIT OF SHAREHOLDERS’ EQUITY

PROBLEM NO. 5

Select the best answer for each of the following:

1. In an examination of shareholder’s equity, an auditor is most concerned that

a. Capital stock transactions are properly authorized.
b. Stock splits are capitalized at par or stated value on the dividend declaration date.
c. Dividends during the year under audit were approved by the shareholders.
d. Changes in the accounts are verified by a bank serving as a registrar and stock
transfer agent.

2. In audit of a medium-sized manufacturing concern, which one of the following areas

can be expected to require the least amount of audit time?
a. Owner’s equity b. Assets c. Revenue d. Liabilities

3. When a corporate client maintains its own stock records, the auditor primarily will rely
upon
a. Confirmation with the company secretary of shares outstanding at year-end.
b. Review of the corporate minutes for data as to shares outstanding.
c. Confirmation of the number of shares outstanding at year-end with the appropriate
state official.
d. Inspection of the stock book at year-end and accounting for all certificate numbers.

4. When a client company does not maintain its own stock records, the auditor should obtain
written confirmation from the transfer agent and registrar concerning
a. Restrictions on the payment of dividends.
b. The number of shares issued and outstanding.
c. Guarantees of preferred stock liquidation value.
d. The number of shares subject to agreement to repurchase

5. The auditor is concerned with establishing that dividends are paid to client corporation
shareholders owning stock as of the
a. Issue date b. Declaration date c. Record date d. Payment date

6. An audit program for the retained earnings account should include a step that requires
verification of the
a. Fair value used to charge retained earnings to account for a two-for-one-stock split.
b. Approval of the adjustment to the beginning balance as a result of a write-down of an
account receivable.
c. Authorization for both cash and stock dividends.
d. Gain or loss resulting from disposition of treasury shares.

7. During an audit of an entity’s shareholders’ equity accounts, the auditor determines whether
there are restrictions on retained earnings resulting from loans, agreements,
or law. This audit procedure most likely is intended to verify management’s assertion of
a. Existence c. Valuation
b. Completeness d. Presentation and disclosure

8. If the auditee has a material amount of treasury stock on hand at year-end, the auditor
should
a. Count the certificates at the same time other securities are counted.
b. Count the certificates only if the company had treasury stock transactions during the
year.
c. No count the certificates if treasury stock is a deduction from shareholders’ equity.
d. Count the certificates only if the company classifies treasury stock with other assets.

9. In performing tests concerning the granting of stock options, an auditor should

a. Confirm the transaction with the Securities and Exchange Commission.
b. Verify the existence of option holders in the entity’s payroll records or stock ledgers.
c. Determine that sufficient treasury stock is available to cover any new stock issued.
d. Trace the authorization for the transaction to a vote of the board of directors.
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CPAR - MANILA AP-9101-2 – AUDIT OF SHAREHOLDERS’ EQUITY

10. The auditor would not expect the client to debit retained earnings for which of the
following transactions?
a. A 4-for-1 stock split.
b. "Loss" resulting from disposition of treasury shares.
c. A 1-for-10 stock dividend.
d. Correction of error affecting prior year's earnings.

END OF 9101-2

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