Chapter11 - Answer

CHAPTER

11

SUBSTANTIVE TESTS OF PROPERTY, PLANT AND EQUIPMENT

11-1.

Factors which facilitate the auditors’ verification of plant and equipment but are not applicable to audit work on current assets include the following: (a) High peso amount of individual items. A relatively few transactions may support a large balance sheet amount. (b) Usually little change in property accounts year to year. Land, buildings, and equipment often remain unchanged for many years; hence there is little accounting activity to verify. In contrast, such current assets as accounts receivable and inventory may have a complete turnover several times a year. (c) Minor effect on net income from cutoff errors. Cutoff errors in recording transactions in plant and equipment are much less likely to have a material effect on net income than are errors in the cutoff of transactions for purchase and sale of merchandise. For example, a cutoff error which causes a P30,000 year-end sales transaction to be recorded a day prior to shipment may cause a P30,000 overstatement of the current year’s pretax income.

11-2.

The auditors must question the service lives adopted by the client for plant assets. To do otherwise would be to fail in the collection of sufficient competent evidence for the client’s depreciation policies and procedures.

11-3.

The principal objective of the auditors in analyzing a Maintenance and Repairs expense account is to disclose any capital expenditures which were erroneously recorded as expense.

11-4.

Documentary evidence usually available in the client’s office to substantiate legal ownership of property, plant, and equipment includes deeds, policies of title insurance or abstract of title and an attorney’s opinion as to title, property tax bills, insurance policies, purchase contracts, purchase orders, invoices, and paid checks. The auditors may also secure written representations from the client as to ownership of these assets.

11-5.

The auditors employ the following substantive tests to detect unrecorded retirements of property, plant, and equipment: (a) If major additions of plant and equipment have been made during the year, ascertain whether old equipment was traded in or superseded by the new units. (b) Analyze the Miscellaneous Revenue account to locate any cash proceeds from sale of plant assets.

11-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition (c) If any of the company’s products have been discounted during the year, investigate the disposition of plant facilities formerly used in manufacturing such products. (d) Inquire of executives and supervisors whether any plant assets have been retired during the year. (e) Examine retirement work orders or other source documents for authorization by the appropriate official or committee. (f) Investigate any reduction of insurance coverage to see whether this was caused by retirement of plant assets.

11-6.

Kris Corporation (a) This is the first audit of Kris Corporation by Ian and Ronna. Moreover, the company has not been audited by other public accountants during the two previous years of operation. Under these circumstances, the auditors must investigate fully transactions relating to plant and equipment during the two prior years of the company’s existence, as well as the records of the year under audit. The adequacy of internal control over plant acquisitions and disposals would be an important part of this review. Since Kris is a relatively new company, this study of prior years’ transactions can be completed within reasonable time limits. The review of prior years’ transactions relating to plant and equipment would include analysis of the Repairs and Maintenance expense account and should bring to light the erroneous treatment of plant acquisitions as revenue expenditures during Years 1 and 2. If Ian and Ronna did not investigate the property transactions of the two prior years and the internal controls in force, there would be no satisfactory support for the balances of the property accounts at the end of Year 3, or for the depreciation expense of the year under audit. Remember that one of the auditors’ basic objectives for plant and equipment is to determine that the property accounts (including the amounts carried forward from prior years) are fairly stated. (b) Both the income statement and the balance sheet prepared at the end of Year 3 would be affected by the errors made in Years 1 and 2. In the balance sheet, the plant and equipment and also the total assets would be understated by the undepreciated cost of the assets which were improperly expensed. Current liabilities and total liabilities would be understated by the additional income taxes applicable to the understatement of prior periods’ net income due to the accounting errors. The retained earnings and total shareholders’ equity would be understated by the difference between the understatement of total assets and the understatement of total liabilities. In the Kris income statement, depreciation expense would be understated, income taxes expense overstated, and net income overstated.

Substantive Tests of Property, Plant and Equipment 11-7.

11-3

Sparrow Company 1.

Change in depreciation method is considered change in accounting estimate --cumulative effect adjustment: a.

No correcting entry

b.

Depreciation Expense Accumulated Depreciation: Machine To record depreciation for 2006.

Previous depreciation amount 2004 P400,000 x (2 x 10%) 2005 (P400,000 - P80,000) x (2 x 10%) = Cost Less:

Accumulated depreciation Carrying value 12.31.05 256,000 – 50,000 Depreciation in 2006 = 8 2.

25,750 25,750

P 80,000 64,000 P144,000 P400,000 144,000 P256,000 = P25,750

Change in estimate--prospective adjustment: a.

No correcting entry

b.

Depreciation Expense Accumulated Depreciation: Machine To record depreciation for 2006. Depreciation base Original life = Annual depreciation =

40,000 40,000 P450,000 = 9 years P50,000

Remaining life =

(9-5) years + 1 year = 5 years P250,000 – P50,000 Book value – Residual value = = P40,000 per year Depreciation = 5 Remaining life 3.

Error--prior period adjustment: a.

Retained Earnings Accumulated Depreciation: Machine Prior period adjustment for error (P80,000 - P72,000).

8,000 8,000

Previous depreciation - erroneously calculated (P200,000 – P20,000) x (2 x 20%) = P72,000 Correct depreciation (P200,000) x (2 x 20%) = P80,000 b.

Depreciation Expense Accumulated Depreciation: Machine To record depreciation for 2006.

48,000 48,000

2006 correct depreciation (P200,000 – P80,000) x (2 x 20%) = P48,000

11-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition

11-8.

Jamboree Trucking Company Requirement (1) Accumulated depreciation on the trucks, January 1, 2003

Truck 1 2 3 4

Cost P120,000 104,000 128,000 150,000

Life 5 5 5 5

Annual Depreciatio n P24,000 20,800 25,600 30,000

Years Owned 3 2½ 1 ½

Accumulate d Depreciatio n P 72,000 52,000 25,600 15,000 P164,600

Note: This schedule is used to help determine the accumulated depreciation to date for each correcting entry. Also see correct depreciation schedule later in solution. July 1, 2003 Correct entry: Cash Accumulated Depreciation: Trucks [P72,000 + (P24,000 x ½)] Loss Trucks

10,000 84,000 26,000 120,000

Entry made: Cash Trucks

10,000 10,000

Correcting entry #1: Accumulated Depreciation: Trucks Retained Earnings Trucks

84,000 26,000 110,000

January 1, 2004 Correct entry: Accumulated Depreciation: Trucks (P25,600 + P25,600) Trucks (new) Cash

51,200 120,000 17,800

Substantive Tests of Property, Plant and Equipment Trucks (old) Gain on exchange Entry made:

11-5

128,000 25,400

Trucks Cash

17,800 17,800

Correcting entry #2: Trucks (new) Accumulated Depreciation: Trucks Trucks (old) Retained earnings

102,200 51,200 128,000 25,400

July 1, 2005 Correct entry: Accumulated Depreciation: Trucks (P15,000 + P30,000 + P30,000 + P15,000) Cash RE on disposition of trucks Trucks

90,000 10,000 50,000 150,000

Entry made: Cash Miscellaneous Revenue Trucks

10,000 500 9,500

Correcting entry #3: Accumulated Depreciation: Trucks Retained Earnings Trucks

90,000 50,500 140,500

Correct depreciation: Truck 1 2 3 4 5 6 Total Depreciation Under (over)

2003 P12,000 P20,800 P25,600 P30,000 – – P88,400

2004 – P20,800 – P30,000 P18,920 – P69,720

2005 – P10,400 – P15,000 P18,920 P12,000 P56,320

2006 – – – – P18,920 P24,000 P42,920

(88,400)

(54,360)

(41,460)

(28,560)

(P94,600  5 = P18,920) (P120,000  5 = P24,000)

11-6


statement

–

P15,360

P14,860

P14,360

Effect of errors on earnings (all reductions) 2003 2004 2005 2006

P26,000 P15,360 P50,500 + P14,860 = P65,360 P14,360

Correcting entry #4: Retained Earnings Depreciation Expense Accumulated Depreciation

30,220 14,360 44,580

Requirement (2) Compound AJE: Accumulated Depreciation: Trucks (P84,000 + P51,200 + P90,000 – P44,580) Retained Earnings (P26,000 – P25,400 + P50,500 + P30,220) Depreciation Expense Trucks (P110,000 + P102,200 – P128,000 – P140,500) 11-9.

180,620 81,320 14,360 276,300

AFH Company Note: This question requires knowledge that corrections of errors in prior years are recorded to Retained Earnings. Adjusting entries at December 31, 2007, to correct the books. The building and machinery should be recorded in separate accounts. Ignore effect on income taxes. Purchase price of P60,000 is a lump-sum purchase. Building Machinery Machinery is valued at 40% x P60,000 Building is valued at 60% x P60,000

P39,000 26,000 P65,000 = =

P24,000 P36,000

60% 40% 100%

Substantive Tests of Property, Plant and Equipment

AJE (1)

(2)

(3)

(4)

(5)

(6)

Machinery Building Property, Plant, and Equipment

24,000 36,000 60,000

Machinery Building Property, Plant, and Equipment The legal fees are allocated in the same proportion as the original purchase.

280 420

Retained Earnings Property, Plant, and Equipment To correct the insurance paid in 2005 that was incorrectly recorded in the asset account.

2,400

Property, Plant, and Equipment Accumulated Depreciation: Building Accumulated Depreciation: Machinery Retained Earnings To remove the depreciation of P6,310 incorrectly credited to Property, Plant, and Equipment in 2005; to credit the correct depreciation to Accumulated Depreciation: Building (P36,420  20); to credit the correct depreciation to Accumulated Depreciation: Machinery (P24,280  8); and to correct the amount recorded as depreciation expense by a credit to Retained Earnings.

6,310

Retained Earnings Property, Plant, and Equipment To correct the 2006 repairs that were incorrectly recorded in the asset account.

2,000

Building Property, Plant, and Equipment To properly classify the addition to the building.

11-7

700

2,400

1,821 3,035 1,454

2,000

10,000 10,000 2006

11-8


(7)

(8)

(9)

(10)

(11)

Property, Plant, and Equipment Accumulated Depreciation: Building Accumulated Depreciation: Machinery Retained Earnings To remove the depreciation of P6,879 incorrectly credited to Property, Plant, and Equipment in 2006; to credit the correct depreciation to Accumulated Depreciation: Building [P1,821 + (P10,000  19)] (this assumes the addition has the same life as the building); to credit the correct depreciation to Accumulated Depreciation: Machinery (P24,280  8); and to correct the amount recorded as depreciation expense by a credit to Retained Earnings.

6,879

Repairs Expense Property, Plant, and Equipment To expense the repairs for 2007, before the books are closed.

3,000

Insurance Expense Prepaid Insurance Property, Plant, and Equipment To correctly classify the 2007 insurance payment, before the books are closed.

1,400 1,400

Machinery Property, Plant, and Equipment To correctly classify the machinery purchased in 2007.

7,000

Loss on Disposal of Machinery Property, Plant, and Equipment Accumulated Depreciation: Machinery Machinery To correctly record the disposal of the machinery in 2007; the machine is 2 years old and so has P200 related accumulated depreciation.

100 500 200

2,347 3,035 1,497

3,000

2,800

7,000

800


(12)

11-10.

Property, Plant, and Equipment Accumulated Depreciation: Building Accumulated Depreciation: Machinery Depreciation Expense To remove the depreciation of P7,421 incorrectly credited to Property, Plant, and Equipment in 2004; to credit the correct depreciation to Accumulated Depreciation: Building; to credit the correct depreciation to Accumulated Depreciation: Machinery [(P24,280 + P7,000 - P800)  8]; and to correct the depreciation expense before the books are closed.

11-9

7,421 2,347 3,810 1,264

Briggs, Inc. Adjusting Journal Entries - 12/31/06 (1)

(2)

(3)

(4)

(5)

(6)

(7)

Organization costs Fixed assets

3,000

Discount on bonds payable Interest expense Fixed assets

5,650 350

Land Fixed assets

3,000

6,000 500,000 500,000


5,000

Land Fixed assets

4,000

Land Fixed assets

7,000

Interest expense

30,000

5,000

4,000

7,000

11-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition Fixed assets (8)

(9)

(10)

(11)

11-11.

30,000

Salaries expense Fixed assets

50,000


40,000

Taxes and licenses Fixed assets

7,000

Building Fixed assets

50,000

40,000

7,000 2,000,000 2,000,000

Aerospace Company Requirement (1) Machinery (cost) Raw materials used Labor Installation cost Materials used in trial runs Factory overhead (incremental) Total Less: Cash discount on materials Net

P13,600 9,800 1,400 600 2,900 P28,300 400 P27,900

Accumulated depreciation - 12/31/06 (P27,900 x 10% x 4/12)

P

Machine Tools (cost) Less: Amortization for 2006 (4/36 x 2,250) Balance, 12/31/06

P 2,250 250 P 2,000

930

Requirement (2) Adjusting Journal Entries - 12/31/06 (1) (2)

Loss on disposition of machinery Machinery Profit on construction Machinery

70 70 6,900 6,900

Substantive Tests of Property, Plant and Equipment (3) (4)

(5)

2,250

Machinery Depreciation expense Accumulated depreciation - machinery

3,462

Purchase discount Machinery

(6)

Machinery Factory overhead control

(7)

11-12.

Machine tools Machinery

Tools expense Machine tools

11-11 2,250 2,532 930

400 400 2,900 2,900 250 250

XYZ Manufacturing Company Adjusting Journal Entries - 12/31/06 AJE (1)

(2)

(3)

Retained Earnings Machinery To correct error in recording purchase of machine on installment basis. List Price P6,000 Add: Installation charges 200 Total P6,200 Total installments paid & installation 7,400 Financing charges P1,200

1,200.00

Retained Earnings Machinery To take up cash discount on machinery purchased on 6/30/03.

160.00

Machinery (new) Allowance for depreciation Machinery (old) To write off machinery traded in for a new one. Cost of new machine: Cash payment P5,000 NBV of old machine 2,620 Total P7,620

2,620.00 2,620.00

1,200.00

160.00

5,240.00

11-12


(4)

(5)

(6)

(7)

Allowance for depreciation Machinery Retained earnings To correct the recording of sale of machinery on 1/1/05. Cost P4,400 Less: Acc. Depr. 2,640 NBV 1,760 Proceeds (2,500 - 125) 2,375 Gain P 615

2,640.00

Allowance for depreciation Machinery Gain on sale of machinery To correct the recording of sale of machinery on 10/1/06. Cost P4,000 Less: Acc. Depr. 3,800 NBV 200 Proceeds 800 Gain P 600

3,800.00

Machinery Allowance for depreciation To set up client’s depreciation provisions from 2002 to 2006 erroneously credited to the Machinery acct. (Schedule A).

19,900.60

Depreciation expense Retained earnings Allowance for depreciation To correct error in depreciation provisions of client (Schedule B).

2,190.90 1,536.50

2,025.00 615.00

3,200.00 600.00

19,900.60

3,727.40

XYZ Manufacturing Corporation Machinery 12/31/06 Balance per ledger (Schedule A) Add (Deduct) Adjustments AJE (1)

P10,964.40 ( 1,200.00)

11-13

Substantive Tests of Property, Plant and Equipment (2) (3) (4) (5) (6)

( 160.00) 2,620.00 ( 5,240.00) ( 2,025.00) ( 3,200.00) 19,900.60 Net

P10,695.60

Balance as adjusted

P21,660.00

Composition: Machine acquired on 9/30/02 Machine acquired on 6/30/03 Machine acquired on 6/30/04 Total

P 6,200.00 7,840.00 7,620.00 P21,660.00

XYZ Manufacturing Corporation Allowance for Depreciation 12/31/06 Balance per ledger Add (Deduct) Adjustments AJE (3) (4) (5) (6) (7) Balance as adjusted

P

0.00

( 2,620.00) ( 2,640.00) ( 3,800.00) 19,900.60 3,727.40 P14,568.00

Composition: A D - Machine acquired on 9/30/02 - Machine acquired on 6/30/03 - Machine acquired on 6/30/04 Total

P 5,270.00 5,488.00 3,810.00 P14,568.00

Supporting Analysis: Schedule A

Machinery Account per Ledger

Date

Particulars

1/1/02

Purchase

9/30/02

Purchase on installment Payments from Sept. to Dec.

Dr

Cr

Balance

P 5,240.00 4,000.00 4,400.00

P13,640.00

2,400.00

16,040.00

11-14


10/10/02 12/31/02

Freight and installation Depreciation (20%)

2003

Schedule B Date Acquired

9/30/02 6/30/03 6/30/04

4,800.00 8,000.00

16,240.00 12,992.00

5,126.72 2,375.00 3,626.38 800.00 2,741.10

17,792.00 25,792.00 20,633.60 25,633.60 20,506.88 18,131.88 14,505.50 13,705.50 10,964.40

2005

2006

5,158.40 5,000.00

Depreciation Schedule Cost

2002

2003

2004

P 5,240 4,000 4,400 6,200 7,840 7,620

P 1,048.00 800.00 880.00 310.00 0.00 0.00

P1,048.00 800.00 880.00 1,240.00 784.00 0.00

P 524.00 800.00 880.00 1,240.00 1,568.00 762.00

Total correct depreciation provision Provision by client (Over) Underprovision 11-13.

P 3,248.00

Installment payments for acquisition on 9/30/02 Purchase Depreciation (20%) Acquisition - old machine traded in Depreciation (20%) Sale Depreciation (20%) Sale Depreciation (20%)

6/30/03 12/31/03 6/30/04 12/31/04 1/1/05 12/31/05 10/1/06 12/30/06

1/1/02

200.00

P 3,038.00 P4,752.00 P 5,774.00 3,248.00 5,158.40 5,126.72 P (210.00) P (406.40) P 647.28

P

0.00 800.00 0.00 1,240.00 1,568.00 1,524.00

P

0.00 600.00 0.00 1,240.00 1,568.00 1,524.00

P5,132.00 3,626,38 P1,505.62

P4,932.00 2,741.10 P2,190.90

Sunlight Service Center Audit Adjustment No. 1 was determined as follows: Client’s Entry

Correct Entry

(1) To record disposal of delivery truck: Cash Trucks

2,000 2,000

Cash 2,000 Accum. Depr. 50,000 Trucks 50,000 Gain/Loss on Disp. 2,000

(2) To record disposal of service truck: Cash Trucks

8,000 8,000

Cash Accum. Depr.

8,000 15,000

Substantive Tests of Property, Plant and Equipment Gain/Loss on Disp. Trucks

11-15

2,000 25,000

(3) To record 2006 depreciation: Depr. Expense Accum. Depr.

95,000 95,000

Depr. Expense Accum. Depr.

101,250 101,250

Correct amount of depreciation determined as follows: Disposal of service truck (1/2 year) Purchase of delivery truck (1/2 year) Purchase of service truck (1/2 year) Two delivery truck @ 10,000 each Fourteen service trucks @ 5,000 each Total

P 2,500 6,000 2,750 20,000 70,000 P101,250

Audit Adjustment as shown below: Accumulated Depreciation - Trucks Depreciation Expense - Trucks Trucks b.

58,750 6,250 65,000

The audit objectives for examining the asset and related accumulated depreciation accounts are: (1)

Existence or occurrence: To establish the physical presence of the assets and the validity of the purchase and sale transactions.

(2)

Rights and obligations: To ascertain that Sunlight owns the trucks.

(3)

Valuation or allocation: To determine that the company has properly recorded the acquisitions and disposals, and that depreciation has been properly calculated for 2006.

(4)

Presentation and disclosure: To resolve that all trucks are used in the company’s operations; that fully-depreciated trucks are removed from the books if no longer in use; that trucks and accumulated depreciation are reflected as operating assets; and that depreciation expense is reflected as an operating expense.

Auditing procedures appropriate in meeting the above objectives are the following: (1) Existence or occurrence, valuation or allocation, and ownership: Trace to last year’s audit workpapers and examine titles for trucks purchased prior to 2006 (to determine that trucks are still owned by the client; examine titles and invoices for trucks purchased in 2006; examine remittance advices, journal entries and bank statement credits for 2006 disposals; and recompute depreciation expense and gain/loss on disposals.

11-16

Solutions Manual to Accompany Applied Auditing, 2006 Edition (2) Presentation and disclosure: Examine subsidiary ledger for fully depreciated assets and inquire as to whether in use. Reclassify as necessary.

11-18 11-13.

Solutions Manual to Accompany Applied Auditing, 2006 Edition Sunlight Service Center (CONTINUED. . . . Requirements a and c)

SUNLIGHT SERVICE CENTER TRUCKS December 31, 2006

Description Assets: Delivery Trucks Service Trucks

Final Balances 12/31/01

Additions

P150,000 P375,000 P525,000 & F

P 60,000  P 27,500  P 87,500 F

Disposals P51,000 P25,000 P76,000 F

12/31/06: Ledger balance AJE No. 1 12/31/06: Audited balances

Accumulated Depreciation: Delivery Trucks Service Trucks

P 95,000 P225,000 P320,000 & F

12/31/06: Ledger balances AJE No. 1

P 26,000 (B) P 75,250 (C) P101,250 F P 95,000 P 6,250 P101,250

P 50,000 15,000 (A) P 65,000 F

Final Balances 12/31/02 P160,000 P377,500 P537,500 F P602,500 P 65,000 P537,500 WP G

P 71,000 P285,250 P356,250 F P415,000 P 58,750 P356,250

Evaluated depreciation policy and estimated lives for reasonableness. No exception: AJE No. 1 Depreciation expense - trucks P 6,250 Accum. depreciation - trucks 58,750 Trucks P65,000 & *

Traced to last year’s working trial balance Traced to remittance advice and cash receipts

F 

Footed and crossfooted Examined invoices and titles

Gain (loss) on Disposals P 2,000 (P2,000) P 0

* (A)

(A) Cost Accum. Depr: 2003 2,500 2004 5,000 2005 5,000 2006 2,500

(1/2 yr.)

Book Value Sales Price Loss

P10,000 8,000 P 2,000

*

20,000 6,000 P 26,000

(1/2 yr.)

70,000 2,500 2,750 P 75,250

(1/2 yr.) (1/2 yr.)

(B) 2 x 10,000 1 x 6,000

WP G 14 x 5,000 1 x 2,500 1 x 2,750

P25,000

(1/2 yr.) 15,000

Substantive Tests of Property, Plant and Equipment 11-14.

11-19

Tatty Company’s Requirement (1) Tatty Company Analysis of Land Account for 2007 Balance at January 1, 2007 Land site number 621: Acquisition cost Commission to real estate agent Clearing costs Less: Amounts recovered Total land site number 621 Land site number 622: Acquisition cost Demolition cost of building Total land site number 622 Balance at December 31, 2007

P 100,000 P1,000,000 60,000 P15,000 (5,000)

10,000 1,070,000 P 300,000 30,000 330,000 P1,500,000

Tatty Company Analysis of Buildings Account for 2007 Balance at January 1, 2007 Cost of new building constructed on land site number 622: Construction costs Excavation fees Architectural design fees Building permit fee Balance at December 31, 2007

P800,000 P150,000 11,000 8,000 1,000

170,000 P970,000

Tatty Company Analysis of Leasehold Improvements Account for 2007 Balance at January 1, 2007 Electrical work Construction of extension to current work area (P80,000 x ½) Office space Balance at December 31, 2007

P500,000 35,000 40,000 65,000 P640,000

11-20

Solutions Manual to Accompany Applied Auditing, 2006 Edition Tatty Company Analysis of Machinery and Equipment Account for 2007 Balance at January 1, 2007 Cost of new machines acquired: Invoice price Freight costs Unloading charges Balance at December 31, 2007

P700,000 P75,000 2,000 1,500

78,500 P778,500

Requirement (2) Items in the fact situation which were not used to determine the answer to Requirement 1 above, and where, or if, these items should be included in Tatty’s financial statements are as follows:

11-15.

a.

Land site number 623, which was acquired for P600,000, should be included in Tatty’s balance sheet as land held for resale.

b.

Painting of ceilings for P10,000 should be included as a normal operating expense in Tatty’s income statement.

c.

Royalty payments of P13,000 should be included as a normal operating expense in Tatty’s income statement.

Nikko Company Note to Instructor: This problem includes material from previous chapters. JOURNAL ENTRIES DURING 2006: (1)

Land Ordinary Shares, P10 par Additional Paid-in Capital a

175,000 a 70,000 105,000

P25 x 7,000

Cash Notes Payable

500,000

Building Cash

700,000

500,000

700,000

Substantive Tests of Property, Plant and Equipment (2)

(3)

(4)

Machine Accumulated Depreciation Machine Cash Gain on exchange

430,000 135,000

Cash Sales Revenue

800,000

Cost of Goods Sold Inventory

350,000

Accounts Payable Cash

400,000

Inventory Accounts Payable

480,000

Dividends Distributed (or Retained Earnings) Cash a

11-21

500,000 60,000 5,000 800,000 350,000 400,000 480,000 92,500 92,500 a

37,000 x P2.50

ADJUSTMENTS AT END OF 2006: Interest Expense Building Interest Payable a b

60,000 a

P500,000 x 12% [(P0 + P700,000)  2] x 12%

Depreciation Expense - Machinery Accumulated Depreciation a

18,000 42,000 b

75,000 a 75,000 a

(P430,000 – P55,000)  5

Rent Expense Prepaid Rent

60,000

Income Tax Expense Income Taxes Payable

90,600 a

a

See income statement

60,000 90,600

11-22

Solutions Manual to Accompany Applied Auditing, 2006 Edition FINANCIAL STATEMENTS FOR 2006: NIKKO COMPANY Income Statement For Year Ended December 31, 2006 Sales revenue Less: Expenses Cost of goods sold Interest expense Depreciation expense Rent expense Operating income Gain on exchange of machinery Income before income taxes Income tax expense (30%) Net income

P800,000 P350,000 18,000 75,000 60,000

Earnings per share (37,000 shares)

(503,000) P297,000 5,000 P302,000 90,600 P211,400 P

5.71

NIKKO COMPANY Statement of Retained Earnings For Year Ended December 31, 2006 Beginning retained earnings Add: Net income

P200,000 211,400 P411,400 (92,500) P318,900

Less: Dividends Ending retained earnings NIKKO COMPANY Balance Sheet December 31, 2006 Assets Cash Inventory Land Building Machine Less: Accumulated depreciation Total Assets

P 587,500 580,000 175,000 742,000 P430,000 (75,000)

355,000 P2,439,500

a b


11-23

Liabilities and Equities

11-16.

Accounts payable Notes payable Interest payable Income taxes payable Total Liabilities

P 480,000 500,000 60,000 90,600 P1,130,600

c

Ordinary shares, P10 par Additional paid-in capital Retained earnings Total Shareholders’ Equity Total Liabilities and Shareholders’ Equity

P 370,000 620,000 318,900 P1,308,900 P2,439,500

d e

a

P540,000 + P500,000 – P700,000 – P60,000 + P800,000 – P400,000 – P92,500 = P587,500

b

P450,000 – P350,000 + P480,000 = P580,000

c

P400,000 – P400,000 + P480,000 = P480,000

d

P300,000 + P70,000 = P370,000

e

P515,000 + P105,000 = P620,000

Apple Company Requirement 1 Total expenses, 2005 = Units sold x (Depletion + Depreciation + Production costs) = (6 x 9,000) x (P3.00a + P0.20b + P8.00) = 54,000 x P11.20 = P604,800

a

Cost – Residual Value Depletion rate Life = in tons P2,000,000  (P100,000 – P200,000) = 700,000 P2,100,000 = 700,000 = P3.00 per ton

11-24

Solutions Manual to Accompany Applied Auditing, 2006 Edition b

Cost – Residual Value Depreciation rate =Life in tons P150,000 – P10,000 =700,000 =

P0.20 per ton

Requirement 2 Cost of inventory, 12/31/2005

=

6 x (10,000 – 9,000) x P11.20

=

P67,200

Requirement 3 Total expenses, 2006 = Units sold x (Depletion + Depreciation + Production costs) = (6 x P11.20) + [(12 x 10,000) – 6,000] x (P3.84a + P0.256b + P8.00) = P67,200 x P1,378,944 = P1,446,144 a

Book value – Residual Value New depletion rate =Remaining Life [P2,000,000  (60,000 x P3.00)] – (P100,000 – P200,000)] = 500,000 P1,820,000 + P100,000 = 500,000 P1,920,000 = 500,000 = P3.84 per ton

b

Book value – Residual Value New depreciation rate =Remaining Life [P150,000  (60,000 x P0.20)] – P10,000 = 500,000 P128,000 = 500,000


=

11-25

P0.256 per ton

11-17. January 1, 2001 Equipment Cash

5,000,000 5,000,000

December 31, 2001 Depreciation Expense Accumulated Depreciation

500,000 500,000

December 31, 2002 Depreciation Expense Accumulated Depreciation

500,000 500,000

January 1, 2003 Equipment Accumulated Depreciation Revaluation Surplus

625,000 125,000 500,000

December 31, 2003 Depreciation Expense Accumulated Depreciation Revaluation Surplus Retained Earnings

562,500 562,500 62,500 62,500


562,500 562,500 62,500 62,500


562,500 562,500 62,500 62,500

January 1, 2006 1) Revaluation surplus

312,500

11-26

Solutions Manual to Accompany Applied Auditing, 2006 Edition Accumulated depreciation Equipment

312,500 625,000

2) Impairment loss / Depreciation expense Accumulated depreciation

500,000 500,000

or Revaluation surplus Impairment loss / Depreciation expense Accumulated depreciation Equipment 11-18.

312,500 500,000 187,500 625,000

Sweetie Company Requirement (a) December 31, 2006 Loss on Impairment / Depreciation........................................................................................ 3,200,000 Accumulated Depreciation—Equipment................................................................. 3,200,000 Cost Accumulated depreciation Carrying amount Fair value Loss in impairment

P9,000,000 1,000,000 8,000,000 4,800,000 P3,200,000

Requirement (b) December 31, 2007 Depreciation Expense............................................................................................................ 1,200,000 Accumulated Depreciation—Equipment................................................................. 1,200,000 New carrying amount Useful life Depreciation per year

P4,800,000 4 years P1,200,000

Requirement (c) Carrying value, 12.31.07 had impairment not been recognized on 12.31.06 Cost Accumulated depreciation (P1,000,000 + P2,000,000) Net carrying value, 12.31.07

P9,000,000

Fair value, 12.31.07

P5,100,000

3,000,000 P6,000,000

Substantive Tests of Property, Plant and Equipment Carrying value, 12.31.07 Recovery of impairment loss

11-27

3,600,000 P1,500,000

Entry will be: Accumulated depreciation Depreciation expense or Gain on recovery of previously recognized impairment 11-19.

1,500,000 1,500,000

Bobby Corporation Requirement (1) BOBBY CORPORATION Land Account (Site Number 501) As of September 30, 2007 Acquisition cost Real estate broker’s commission Legal fees Title guarantee insurance Cost of razing existing building Balance, September 30, 2007

P600,000 36,000 6,000 18,000 75,000 P735,000

Requirement (2) BOBBY CORPORATION Capitalized Cost of Office Building As of September 30, 2007 Contract cost Plan, specifications, and blueprints Architects’ fees for design and supervision Capitalized interest--2006 (P900,000 x 14% x 10/12) Capitalized interest--2007 (P2,300,000 x 14% x 9/12) Total capitalized cost, September 30, 2007

P3,000,000 12,000 95,000 105,000 241,500 P3,453,500

Requirement (3) BOBBY CORPORATION Computation of Depreciation of Office Building Using 150% Declining Balance Method For the Year Ended December 31, 2007 Capitalized cost 150% declining balance rate (100%  40 years = 2.5% x 1.5) Annual depreciation

P3,453,500 x 3.75% P 129,506

11-28

Solutions Manual to Accompany Applied Auditing, 2006 Edition Depreciation October 1 to December 31, 2007 (P129,506 x 3/12)

P

32,377

Chapter11 - Answer

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