Exercises and Problems Links:

Chapter 10 Exercise 1
Exercise 2
Exercise 3
Chapter 16 Problem 1
Problem 3
Problem 4
Exercise 1

Required:
a.For each of the preceding questions, state the purpose of the control.
b.For each of the preceding questions, identify the type of financial statementerror that could occur if the c
c.For each of the potential errors in part b, list an audit procedure that can beused to determine whether a

No. a b
1 To guarantee that The loss of assets as a
2 appropriate management
To ensure that note result of paying
Erroneous excessive
disclosure or
3 has approved
transactions any
are note
accurately
To avoid misusing notes interest rates
duplicated or diverting
inaccuracies in
Inaccurate cash and liability
liabilities.
and completely
andguarantee
money setthat outpayments
for money
the noteto unapproved
payable.
statements.
4 To Loss of cash.
documented.
notes. parties.
5 for ensure
To notes are thatnot
allmade Inaccurate statement of
6 more
For than
transactions once.
pertaining
the additional to
purpose notes payable.
Inaccurate reporting of
notes are in line with
of ensuring that only the interest expenses and
account balances.
correct interest amount is associated accruals.
paid and documented.
he control.
ancial statementerror that could occur if the control were not in effect.
dure that can beused to determine whether a material error exists.

c
For necessary
authorization, reviewbe
A master file should note
request forms.
maintained,
Check to seesoif check to see
tasks are
whether
separated.
Be it is, then compare
Do all payment
sure to check
the detailed
substantive contents to the
notes for
Check seetasks
if on a
to cancellation.
control.
regular basis.
reconciliations
Check to see ifare interest
performed
calculations are regular
on a internally
basis and On
validated. confirm
a testthe
basis,
reconciliation.
recalculate interest.
The auditor should review the bond indenture at the time a bond is issued and anytime subsequent changes are ma

a. Briefly identify the information the auditor would expect to obtain from a bond indenture. List at least five
relevant to the conduct of the audit.
1 Stated interest rate
2 Face value of the bond
3 Maturity date of the bond
4 Callable provisions if any
5 Sinking fund provisions
6 Conversion terms and privileges
7 Underwriters and its responsibilities
8 Financial operating constraints
9 Asset claims

In general, auditors are not needed to confirm that each individual bondholder is liable because:
b. Because auditors
• Independent are especially
bond trustees concerned
handle the majority ofwith
bondthe potential understatement
transactions. The bond trusteeofmayliabilities,
provideshould they c
confirmations.
bondholders? State your rationale.
• An auditor can quickly confirm that the business has obtained the proper proceeds from borrowers, so confirming
converted to securities or the holder is paid along with the reduction in liabilities. Both transactions can be verified b
A bond discount will result, if a bond is sold for less than its face value, or if the stated interest rate is lower than the
c. A company
revenues issued
with the bonds
bond's statedatinterest
a discount. Explain
rate, the amounthowof the
the amount
discount of
is the discount
computed. Theiseffective
computed and how
interest th
rate co
whether the amount is properly amortized each year.
of the bond discount can be calculated by auditors using spreadsheet programs for each time period, and they can
independently determined amount.

d. Explain how the auditor could verify that semiannual interest payments are made on the bond each year.
- By attesting to the payments made to the bond trustee, the auditor can confirm this.
e. The company has a 15-year, $20 million loan that is due on September 30 of next year. It is the company’
-but it is waiting
Because for isthe
the bond best
due time
in the to issue
near future,new debt.evidence
the early Becausesuggests
its intentthat
is to issue the
it should bond next
be reported as ayear, the liab
current co
need not beprospectus
(SEC)-filed classifiedas aswell
a current liability. with
as agreements What evidence should
underwriters the auditor
are examples gather
of legal to that
papers determine the may
an auditor appro a
market changes to obtain assurance about the likelihood of refinancing in accordance with the provisions of the pre
 bsequent changes are made to it.

denture. List at least five specific pieces of information that would be

cause:
liabilities,
may provideshould they confirm the existence of the liability with individual
confirmations.
borrowers, so confirming the existence of responsibility. Either the bond is
sactions can be verified by the auditor.
erest rate is lower than the actual interest rate. By contrasting the available net
eiseffective
computed and how
interest the auditor
rate could could determine
be calculated using this net profit.The amortization
ime period, and they can then compare the recorded amount to the

e on the bond each year.

year. It is the company’s intent to refinance the bond before it is due,

eereported
bond nextas ayear, the liability.
current company believes
The thatand
Securities theExchange
existing $20 million bond
Commission
r to that
pers determine the may
an auditor appropriate classification
also examine. of the
Additionally, thebond?
auditor can assess bond
h the provisions of the preliminary prospectus.
 The following convenants are extracted from a bond indenture. The indenture
provides that failure to comply with its terms in any respect automatically
advances the due date of the loan to the date of noncompliance (the maturity
date is 20 years hence). Identify the audit steps that should be taken or
reporting requirements necessary Exercise 3
in connection with each one of the followng
scenarios:
The debtor company shall endeavor to maintain a working capital ratio of 2 to 1 at all
times, and, in any fiscal year following a failure to maintain the said ratio, the company
A shall restrictcompany
The debtor compensation of the all
shall insure CEO and executive
property officersfor
that is security tothis
a total
debtofagainst
no more loss
B than
The P500,000.
debtor Executive
company shall officers
pay all for
taxes this purpose
legally shall
assessed include
against the
thechairman
by fire to the extent of 100% of its value. Insurance policies securing this protection property of the
that
board
serves ofas
shall be directos,
security
filed president,
for trustee.
with the all within
this debt vice presinets, the secretary,
the time provided by lawandfor the treasurer.
payment without
C
penalty
A sinking fund shall be deposited with the trustee by semiannual payments of of the
and shall receipted tax bills or equally acceptable evidence of payment
D same with the
P300,000, fromtrustee.
which the trustee shall, at her discretion, purchase bonds of this issue
 scenario is to check the statement of financial position at
beginning and through the previous fiscal year to verify the
working capital ratio of the debtor company. Since the formula
for working capital ratio is current assets/ current liabilities,
these two accounts
The following can be
audit steps arefound on the for
necessary balance sheet of (1)
this scenario: the
company. The auditor also neeeds to
With regards to debt covenant compliance -whether debt be aware of restrictions
related
AUDIT
covenants to STEPS
the
arecompensation
THAT SHOULD
calculated so he BE
accurately- needs to check
TAKEN
the client's the officers'
copies of the
The procedure
compensation
insurance that
for
policies the
or auditor
compliance
certificates needs
withof the to perform
limitation
insurance if
must istheto
be verify to
working
It
theis payments
theratio
capital auditor'smade
isthe
lessrepsobsibility
to the
than 2:1.sinkingto examine
Then, fund andthat
to purchase
determine verifythe thebonds.
the
examined
client's tax by
payment auditor; (2)
receipts prepare
for all theschedule
property ofcovered
book value;
on
In
(3) doing
restrictionsthis,
appraised arehe
or must confirm
adequately
estimated the value
disclosed
actual purchase
in the
and of the bonds
financial
coverage for andthe
indenture.
the sinking Determine if all taxes have been paid before the
A and fund
statements.
report;
penalty-free (4) balance
confirm
period ended
with the trustee.
insurance
using the policies
local
Keep track
directly
tax laws with of
andtheproof
B cancellation
trustee of the or cremation
debt security. certificates of bonds or similar
vouchers. Verify
of bond destruction with
forthe trustee who
cancelled bonds. is inAfterwards,
charge of the tax the
report
C receipts if the vouchers are in any way insufficient.
fund as an asset, ideally including its composition in terms of
D cash and bonds held alive that were owned.
Required: Identify deficiencies in Mr. Balagtas' statement of financial position, considering both his draf
a. Indicate the proper treatment of each item you have listed as a deficiency.
b. In addition to the changes you proposed in [a], what items must be included to provide the ba

a. Deficiency Correct Treatment

1 Capitalization of expenses: Treat all the items as expense
Research and Development
Marketing Research
Personnel Recruitment and Training
Legal fees relative to organization of the corporation
Operating Expenses

2 No depreciation was taken on machinery. Expense appropriate amounts

Ordinary shares account does not reflect the par value of the The statement should be prov
3 outstanding shares (11,000). Increase ordinary
and the bases shares by pp
for assigning
recorded at fair value; service
No statement of shareholders’ equity and explanation of shares
4 Additional paid-in capital may
issued is presented.
“Deficit accumulated during d
5 No accumulated deficit presented The amount results from corre

b. Additional items which should be included are:

1 Income statement, including amounts of revenue and expenses recognized since the incepti

2 Statement of cash flows, including cumulative amounts of sources and uses of cash since th

3 Additional disclosures: identification of the company as a development - stage enterprise, an

n, considering both his draft of the statement and the additional information which he has provided.
eficiency.
e included to provide the bank with financial statementsthat are prepared in conformity with generally accepted acco

Correct Treatment
eat all the items as expenses in 20X7 income statement.

pense appropriate amounts in the 20X7 income statement.

.
e statement should be provided, including dates and numbers of shares issued, peso amounts assigned,
crease ordinary
d the bases shares by peso
for assigning par value
land of 1,000inshares.
values noncash transactions. Also, given by Mario should be
corded at fair value; services by Pedro should be recognized as an expense at fair value.
ditional paid-in capital may be recognized as the result of the above.
eficit accumulated during development stage” should be included in the shareholders’ equity section.
e amount results from corrections made in items 1 and 2 above.

ecognized since the inception of the enterprise in 2006.

s and uses of cash since the inception of the enterprise

ment - stage enterprise, and description of significant development – stage activities.

enerally accepted accounting principles?

ts assigned,
ould be
CH 16 PROBLEM 3

Audit of Various Intangible Assets

Lee Manufacturing Corporation was incorporated on January 3, 20X6. The corporation's

financial statement for its first year's operations were not examine by a CPA. You have been
engage to examine the financial statements for the year ended December 31, 20X7, and
your examination is substantially completed. The corporation's trial balance at December 31,
20X7 appear as follows:

Debit Credit
Cash 61,000
Accounts Receivable 92,500
Allowance for Doubtful Accounts 500
Inventories 38,500
Machinery 75,000
Equipment 29,000
Accumulated Depreciation 10,000
Patents 85,000
Leasehold Improvements 26,000
Prepaid Expenses 10,500
Organization Costs 29,000
Goodwill 24,000
Licensing Agreement No. 1 50,000
Licensing Agreement No. 2 49,000
Accounts Payable 147,500
Unearned Revenue 12,500
Share Capital 300,000
Retained Earnings, January 1, 20X7 27,000
Sales 768,500
Cost of Goods Sold 454,000
Selling and General Expenses 173,000
Interest Expense 3,500
Extraordinary Losses 12,000
Total 1,239,000.00 1,239,000.00
WP1_a
Lee Manufacturing Corporation
Financial Statement Worksheet
For the Year Ended December 31, 20X

Trial Balance Adjustments

General Ledger Accounts Debit Credit PAJE Debit
Cash ₱61,000.00
Accounts receivable 92,500.00 ₱2,500.00
Allowance for doubtful accounts ₱500.00
Inventories 38,500.00
Machinery 75,000.00 PAJE 1 17,000.00
Equipment 29,000.00 PAJE 9 8,500.00
Accumulated depreciation 10,000.00
Patents 85,000.00
Leasehold improvements 26,000.00
Prepaid expenses 10,500.00
Organization costs 29,000.00
Goodwill 24,000.00
Licensing agreement No. 1 50,000.00

Licensing agreement No. 2 49,000.00 PAJE 3 1,000.00

Accounts payable 147,500.00
Unearned revenue 12,500.00
Capital stock 300,000.00
Retained earnings, Jan. 1, 20X7 27,000.00
Sales 768,500.00
Cost of goods sold 454,000.00 PAJE 2 3,400.00
PAJE 6 10,000.00
PAJE 10 1,500.00
Selling and general expenses 173,000.00 PAJE 7 8,000.00
Start-up expenses - PAJE 7 16,000.00
PAJE 8 29,000.00
Interest expense 3,500.00
Extraordinary losses 12,000.00
Accumulated amortization:
Patents
Accumulated amortization:
Leasehold improvements
Accumulated amortization:
Licensing agreements
Prior period adjustment – PAJE 4 1,250.00
Licensing agreement No. 1 PAJE 5 30,000.00
Prior period adjustment –
Amortization of leasehold improvements PAJE 10 1,500.00
Net income for 20X7
Totals ### ### ₱129,650.00

Prepared by:
GFO 4.11.23

Generally, adjustments in the current period that could have been determined by management in a prior period sho
period. However, because the 20X7 financial statements were not prepared in conformity with generally accepted a
considered to be errors and treated as prior period adjustments and, therefore, should be applied against beginning

PAJE 1
Machinery 17,000
Patents 17,000

PAJE 2
Cost of Goods Sold 3,400 Solution;
Accumulated Amortization: Patents 3,400 68,000 / 20 years

PAJE 3
Licensing Agreement No. 2 1,000
Unearned Revenue 1,000

PAJE 4 Note: Under the revised PAS 38, intang

Prior Period Adjustment: Licensing A 1,250 useful lives need not be amortize
Licensing Agreement No. 1 1,250
However, it can also be solved b
PAJE 5 Agreement #1. The flood that ren
Prior Period Adjustment: Licensing A 30,000 should be fully disclosed in the D
Licensing Agreement No. 1 30,000

Solution:
To write off the permanent 60% reduction in the expected revenue producing value
of licensing agreement no. 1 caused by the December 2006 explosion (60% x P50,000).

PAJE 6
Cost of Goods Sold 10,000
 Accumulated Amortization: Licensing Agreement 10,000

Solution:
Licensing Agreement No. 1 (P48,000+P2,000) /10 5000
Licensing Agreement No. 2 (P50,000 / 10) 5000
10000
PAJE 7
Selling ang General Expense 8,000
Start up Expense 16,000
Goodwill 24,000

PAJE 8
Start up Expense 29,000
Organizational Costs 29,000

PAJE 9
Equipment 8,500
Accounts Receivable - Lessor 2,500
Leasehold Improvements 11,000

PAJE 10
Retained Earnings 1,500
Prior Period Adjustment : Amortizati 1,500
Accumulated Amortization: Leasehold Improvem 3,000

Solution:
Based on 10 year life of lease:
(15,000/10) 3000
Manufacturing Corporation
ncial Statement Worksheet
ear Ended December 31, 20X7

Adjustments Income Statement Balance Sheet

PAJE Credit Debit Credit Debit Credit
₱61,000.00
95,000.00
-500.00
38,500.00
92,000.00
37,500.00
-10,000.00
PAJE 1 ₱17,000.00 68,000.00
PAJE 9 11,000.00 15,000.00
10,500.00
PAJE 8 29,000.00
PAJE 7 24,000.00
PAJE 4 1,250.00 19,500.00
PAJE 5 30,000.00
50,000.00
₱147,500.00
PAJE 3 1,000.00 13,500.00
300,000.00
-27,000.00
₱768,500.00
₱464,400.00

181,000.00
45,000.00

3,500.00
12,000.00

PAJE 2 3,400.00 -3,400.00

PAJE 10 3,000.00 -3,000.00

PAJE 6 10,000.00 -5,500.00

 -30,500.00

-1,500.00
62,600.00 62,600.00
₱129,650.00 ₱768,500.00 ₱768,500.00 ₱464,600.00 ₱464,600.00

nagement in a prior period should enter into the determination of net income in the current
mity with generally accepted accounting principles, these retroactive adjustments are
d be applied against beginning retained earnings.

000 / 20 years

der the revised PAS 38, intangible assets with indefinite

eful lives need not be amortized but periodically assessed for possible impairment.

wever, it can also be solved by disregarding the 40-year amortization period for Licensing
reement #1. The flood that rendered Licensing Agreement #1 worthless in January 2007
ould be fully disclosed in the December 31, 2006 statements.
CHAPTER 16 - PROBLEM 4

Required:
(a) Prepare a schedule showing the intangibles section of Tan's statement of financial position at Decem
(b) Prepare a schedule showing the income statement effect for the year ended December 31, 20x6. Sh

Requirement A
Jo Tan Company
INTANGIBLES SECTION OF BALANCE SHEET
December 31, 20X6

Patent from Francis Argante Company, net of

accumulated amortization of P560,000 (Schedule 1) P 1,440,000
Franchise from JC Company, net of accumulated
amortization of P48,000 (Schedule 2) 432,000
Total Intangibles P 1,872,000

Schedule 1:
Cost of patent at date of purchase P 2,000,000
Amortization of patent for 20X5 (P2,000,000 / 10 years) (200,000)
1,800,000
Amortization of patent for 20X6 (P1,800,000 / 5 years) (360,000)
Patent Balance P 1,440,000

Schedule 2:
Cost of franchise at date of purchase P 480,000
Amortization of franchise for 20X6 (P480,000 / 10 years) (48,000)
Franchise Balance P 432,000

Jo Tan Company
Proposed Adjusting Entries
December 31, 20X6

PAJE 1
Retained Earnings P200,000
Accumulated Amortization- Patent P200,000

PAJE 2
Amortization Expense 360,000
 Accumulated Amortization - Patent 360,000

PAJE 3
Amortization Expense 48,000
Accumulated Amortization - Franchise 48,000

PAJE 4
Franchise Fee 125,000
Cash 125,000

PAJE 4
Research and Development Expense 433,000
Cash 433,000
nancial position at December 31, 20x6. Show supporting computations in good form.
d December 31, 20x6. Show supporting computations in good form.

Requirement B
Jo Tan Company
INCOME STATEMENT EFFECT
For the year ended December 31, 20X6

Patent from Francis Argante Company:

Amortization of patent for 20x6 (1,800,000/5years) P 360,000
Francise from JC Company:
Amortization of franchise for 20x6 48,000
Franchise fee paid to JC Company (P2,500,000 x 5 125,000
Research and Development Expense 433,000
Total Expenses P 966,000