Page 1 of 11

CEBU CPAR CENTER

Mandaue CIty
AUDITING PROBLEMS
AUDIT OF LIABILITIES

PROBLEM NO. 1
In the audit of the Heats Corporation’s financial statements at December 31, 2005, the
chief accountant of the said corporation provided the following information:
Notes payable:
Arising from purchase of goods 304,000
Arising from 5 year-bank loans, on which marketable securities
valued at P600,000 have been pledged as security, P400,000 due
on June 30, 2006; P100,000 due on Dec. 31, 2006 500,000
Arising from advances by officers, due June 30, 2006 50,000
Reserve for general contingencies 400,000
Employees’ income tax withheld 20,000
Advances received from customers on purchase orders 64,000
Containers’ deposit 50,000
Accounts payable arising from purchase of goods,
net of debit balances of P30,000 170,000
Accounts receivable, net of credit balances P40,000 360,000
Cash dividends payable 80,000
Stock dividends payable 100,000
Dividends in arrears on preferred stock, not yet declared 200,000
Convertible bonds, due January 31, 2007 1,000,000
First mortgage serial bonds, payable in semi-annual installments
of P50,000, due April 1 and October 1 of each year 2,000,000
Overdraft with Allied Bank 90,000
Cash in bank balance with PNB 390,000
Estimated damages to be paid as a result of unsatisfactory
performance on a contract 160,000
Estimated expenses on meeting guarantee for service
requirements on merchandise sold 120,000
Estimated premiums payable 75,000
Deferred revenue 87,000
Accrued interest on bonds payable 360,000
Common stock warrants outstanding 120,000
Common stock options outstanding 210,000
Unused letters of credit 400,000
Deficiency VAT assessment being contested 500,000
Notes receivable discounted 200,000

On March 1, 2006, the P400,000 note payable was replaced by an 18-month note for the
same amount. Heats is considering similar action on the P100,000 note payable due on
December 31, 2006. The 2005 financial statements were issued on March 31, 2006.

On December 1, 2005, a former employee filed a lawsuit seeking P200,000 for unlawful
dismissal. Heats’ attorneys believe that the suit is without merit. No court date has been
set.

On January 15, 2006, the BIR assessed Heats an additional income tax of P300,000 for
the 2003 tax year. Heats’ attorneys and tax accountants have stated that it is likely that
the BIR will agree to a P200,000 settlement.

AP-5902
 Page 2 of 11

REQUIRED:
Based on the above and the result of your audit, compute for the following as of December
31, 2005:
1. Total current liabilities
a. P2,500,000 b. P2,100,000 c. P2,300,000 d. P2,400,000
2. Total noncurrent liabilities
a. P3,300,000 b. P2,900,000 c. P3,000,000 d. P3,400,000
3. Total liabilities
a. P5,200,000 b. P5,000,000 c. P5,400,000 d. P5,800,000

PROBLEM NO. 2
The following information relates to Sonic Company’s obligations as of December 31,
2005. For each of the numbered items, determine the amount if any, that should be
reported as current liability in Sonic’s December 31, 2005 balance sheet.

1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net of P240,000
debit balances in suppliers’ accounts. The unpaid voucher file included the following
items that not had been recorded as of December 31, 2005:
a) A Company – P224,000 merchandise shipped on December 31, 2005, FOB
destination; received on January 10, 2006.
b) B, Inc. – P192,000 merchandise shipped on December 26, 2005, FOB shipping
point; received on January 16, 2006.
c) C Super Services – P144,000 janitorial services for the three-month period ending
January 31, 2006.
d) MERALCO – P67,200 electric bill covering the period December 16, 2005 to
January 15, 2006.
On December 28, 2005, a supplier authorized Sonic to return goods billed at P160,000
and shipped on December 20, 2005. The goods were returned by Sonic on December
28, 2005, but the P160,000 credit memo was not received until January 6, 2006.
a. P5,923,200 b. P5,712,000 c. P5,601,600 d. P5,841,600

2. Payroll:
Items related to Sonic’s payroll as of December 31, 2005 are:
Accrued salaries and wages P776,000
Payroll deductions for:
Income taxes withheld 56,000
SSS contributions 64,000
Philhealth contributions 16,000
Advances to employees 80,000
a. P776,000 b. P992,000 c. P832,000 d. P912,000

3. Litigation:
In May, 2005, Sonic became involved in a litigation. The suit is being contested, but
Sonic’s lawyer believes it is possible that Sonic may be held liable for damages
estimated in the range between P2,000,000 and P3,000,000, and no amount is a better
estimate of potential liability than any other amount.
a. P0 b. P2,000,000 c. P3,000,000 d. P2,500,000

AP-5902
 Page 3 of 11

4. Bonus obligation:
Sonic Company’s president gets an annual bonus of 10% of net income after bonus
and income tax. Assume the tax rate of 30% and the correct income before bonus and
tax is P9,600,000. (Ignore the effects of other given items on net income.)
a. P722,600 b. P395,000 c. P2,240,000 d. P628,000

5. Note payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on
December 31, 2005. The note is dated October 1, 2004, bears interest at 18%, and is
payable in three equal annual installment of P800,000. The first interest and principal
payment was made on October 1, 2005.
a. P800,000 b. P908,000 c. P72,000 d. P872,000

6. Purchase commitment:
During 2005, Sonic entered in a noncancellable commitment to purchase 320,000 units
of inventory at fixed price of P5 per unit, delivery to be made in 2006. On December
31, 2005, the purchase price of this inventory item had fallen to P4.40 per unit. The
goods covered by the purchase contract were delivered on January 28, 2006.
a. P0 b. P1,600,000 c. P1,408,000 d. P192,000

7. Deferred taxes:
On December 31, 2005, Sonic’s deferred income tax account has a 2005 ending credit
balance of P772,800, consisting of the following items:
Caused by temporary differences in accounting Deferred tax
For gross profit on installment sales P376,000 Cr.
For depreciation on property and equipment 576,000 Cr
For product warranty expense 179,200 Dr
P772,800 Cr.
a. P772,800 b. P952,000 c. P196,800 d. P0

8. Product warranty:
Sonic has a one year product warranty on selected items in its product line. The
estimated warranty liability on sales made during 2004, which was outstanding as of
December 31, 2004, amounted to P416,000. The warranty costs on sales made in
2005 are estimated at P1,504,000. Actual warranty costs incurred during the current
2005 fiscal year are as follows:
Warranty claims honored on 2004 sales P 416,000
Warranty claims honored on 2005 sales 992,000
Total warranty claims honored P1,408,000
a. P0 b. P1,504,000 c. P96,000 d. P512,000

9. Premiums:
To increase sales, Sonic Company inaugurated a promotional campaign on June 30,
2005. Sonic placed a coupon redeemable for a premium in each package of product
sold. Each premium costs P100. A premium is offered to customers who send in 5
coupons and a remittance of P30. The distribution cost per premium is P20. Sonic
estimated that only 60% of the coupons issued will be redeemed. For the six months
ended December 31, 2005, the following is available:
Packages of product sold 160,000
Premiums purchased 16,000
Coupons redeemed 64,000
a. P1,728,000 b. P1,152,000 c. P1,600,000 d. P576,000

AP-5902
 Page 4 of 11

10. Due to Five Six Finance company:

Sonic’s accounting records show that as of December 31, 2005, P1,280,000 was due
to Five Six Finance Company for advances made against P1,600,000 of trade accounts
receivable assigned to the finance company with recourse.
a. P0 b. P1,600,000 c. P320,000 d. P1,280,000

PROBLEM NO. 3
In conjunction with your firm’s examination of the financial statements of Pistons
Company as of December 31, 2005, you obtained from the voucher register the
information shown in the working paper below.
Item Entry Voucher Account
No. Date Ref. Description Amount Charged
1 12.18.05 12-202 Supplies, purchased FOB
destination, 12.15.05; Supplies on
received, 12.17.05 20,000 hand
2 12.18.05 12-204 Auto insurance, 12.15.05 to Prepaid
12.15.06 24,000 insurance
3 12.21.05 12-206 Repair services; received Repairs and
12.20.05 24,000 maintenance
4 12.21.05 12-214 Merchandise shipped FOB
shipping point, 11.20.05;
received, 12.4.05 17,000 Inventory
5 12.21.05 12-219 Payroll, 12.6.05 to 12.20.05 Salaries and
(12 working days) 69,000 wages
6 12.26.05 12-221 Subscription to tax reporting Dues and
service for 2006 5,000 subscription
expense
7 12.28.05 12-230 Utilities for December 2005 29,000 Utilities expense
8 12.28.05 12-234 Merchandise shipped FOB
destination, 12.24.05;
received, 1.2.06 111,500 Inventory
9 12.28.05 12-243 Merchandise shipped FOB
destination, 12.26.05;
received, 12.29.05 84,000 Inventory
10 01.02.06 01-001 Legal services, received Legal and
12.28.05 46,000 professional
expense
11 01.02.06 01-002 Medical services for
employees for December
2005 25,000 Medical expense
12 01.05.06 01-003 Merchandise shipped FOB
shipping point, 12.29.05;
received, 1.4.06 55,000 Inventory
13 01.10.06 01-004 Payroll, 12.21.05 to 01.05.06
(12 working days in total, Salaries and
4 working days in Jan.) 72,000 wages
14 01.10.06 01-005 Merchandise shipped FOB
shipping point, 1.2.06;
received, 1.5.06 64,000 Inventory
15 01.12.06 01-006 Manufacturing royalties, Manufacturing
Dec. 2005 39,000 costs

AP-5902
 Page 5 of 11

Item Entry Voucher Account

No. Date Ref. Description Amount Charged
16 01.12.06 01-007 Merchandise shipped FOB
destination, 1.3.06;
received, 1.10.06 38,000 Inventory
17 01.13.06 01-008 Maintenance services, 9,000 Repairs and
received 1.9.06 maintenance
18 01.14.06 01-009 Interest on bank loan,
10.12.05 to 1.10.06 30,000 Interest expense
19 01.15.06 01-010 Manufacturing equipment, Machinery and
installed on 12.29.05 254,000 equipment
20 01.15.06 01-011 Dividends declared, Dividends
12.15.05 160,000 payable

Accrued liabilities as of December 31, 2005 were as follows:

Accrued payroll 48,000
Accrued interest payable 26,667
Dividends payable 160,000
Accrued royalties payable 39,000

The Accrued payroll, Accrued interest payable, and Accrued royalties payable accounts
were reversed on January 1, 2006.

REQUIRED:
Prepare adjusting entries as of December 31, 2005 based on your review of the data given
above.

PROBLEM NO. 4
During your regular annual audit of Rockets Company for the year ended December 31,
2005, you obtain the following evidence and data relative to your examination of the bonds
payable and related accounts.
From your permanent file working papers:
Client is authorized to issue 20,000 bonds with par value of P1,000 each. Bonds are dated
May 1, 2002 and are due May 1, 2012. Interest at 12% per annum is due semiannually
every May 1 and November 1.
The December 31, 2004 balance of P9,500,000 represents proceeds from issuance of
10,000 bonds on November 2, 2003.
From the client’s ledger:
12%, 10-year Bonds Payable
12/31/2004 Balance P9,500,000
07/01/2005 CR 2,100,000

Interest Expense
05/01/2005 CV-120 P600,000 07/01/2005 CR P40,000
11/01/2005 CV-531 720,000

AP-5902
 Page 6 of 11

From supporting documents:

CR Cash receipts entry for issuance of 2,000 bonds for a total of P2,100,000 on
July 1, 2005. Trustee’s remittance statement attached.
Entry recorded
Cash P2,140,000
Bonds Payable P2,100,000
Interest expense 40,000
CV-120 Cash payment to trustee for November 1, 2004 through April 30, 2005 interest.
Paid check to trustee attached.
CV-531 Cash payment to trustee for May 1, 2005 through October 31, 2005 interest.
Paid check to trustee attached.
REQUIRED:
1. Adjusting journal entries as of December 31, 2005. Use the straight line method to
amortize bond discount and premium, if any.
2. Compute for the adjusted balances of the following as of December 31, 2005:
a. Bonds payable d. Accrued interest
b. Bond discount e. Interest expense
c. Bond premium

PROBLEM NO. 5
Wizards Company presented to you their records in connection with the audit of the
company’s financial statements for the year ended December 31, 2005. This is the first
time the company has been audited. The company floated a serial bond issue in 2003.
Your audit showed the following details of the issue and the accounts as of December 31,
2005:
Total amount P5,000,000
Date of issue October 2, 2003
Proceeds from issue P4,900,000
Interest rate 5% per annum
Interest payment date October 1
Maturity date P1,000,000 annually, starting October 1, 2005
5% Serial Bonds Payable
10/02/2005 VR P1,000,000 10/02/2003 CR P4,900,000

Accrued Interest Payable

01/02/05 P62,500

REQUIRED:
1. Adjusting journal entries as of December 31, 2005. Use the bond outstanding
method to amortize bond discount and premium, if any.

2. Compute for the adjusted balances of the following as of December 31, 2005:
a. Bonds payable
b. Bond discount
c. Accrued interest payable
d. Bond interest expense

AP-5902
 Page 7 of 11

PROBLEM NO. 6
On January 2, 2004, the Suns, Inc. issued P2,000,000 of 8% convertible bonds at par.
The bonds will mature on January 1, 2008 and interest is payable annually every January
1. The bond contract entitles the bondholders to receive 6 shares of P100 par value
common stock in exchange for each P1,000 bond. On the date of issue, the prevailing
market interest rate for similar debt without the conversion option is 10%.

On December 31, 2005, the holders of the bonds with total face value of P1,000,000
exercised their conversion privilege. In addition, the company reacquired at 110, bonds
with a face value of P500,000.

The balances in the capital accounts as of December 31, 2004 were:

Common stock, P100 par, authorized 50,000 shares, issued

and outstanding, 30,000 shares P3,000,000
Premium on common stock 500,000

Market value of the common stock and bonds were as follows:

Date Bonds Common stock

December 31, 2004 118 40
December 31, 2005 110 42

QUESTIONS:
Based on the above and the result of your audit, answer the following:
1. How much of the proceeds from the issuance of convertible bonds should be allocated
to equity?
a. P634,000 b. P126,816 c. P221,664 d. P0
2. How much is the carrying value of the bonds payable as of December 31, 2004?
a. P2,000,000 b. P1,389,400 c. P1,796,170 d. P1,900,502
3. How much is the interest expense for the year 2005?
a. P160,000 b. P138,940 c. P179,617 d. P190,050
4. The entry to record the conversion on December 31, 2005 will include a credit to APIC
of
a. P365,276 b. P400,000 c. P307,893 d. P0
5. How much is the loss on bond reacquisition on December 31, 2005?
a. P50,000 b. P96,053 c. P67,362 d. P0

PROBLEM NO. 7
In connection with your audit of Ginebra Corporation’s financial statements for the year
2005, you noted the following liability account balances as of December 31, 2004:
Note payable, bank P 5,600,000
Liability under finance lease 430,000
Deferred income taxes 700,000
Transactions during 2005 and other information relating to Ginebra’s liabilities were as
follows:
a. The principal amount of the note payable is P5,600,000 and bears interest at 12%.
The note is dated April 1, 2004 and is payable in four equal annual installments of

AP-5902
 Page 8 of 11

P1,400,000 beginning April 1, 2005. The first principal and interest payment was
made on April 1, 2005.
b. The capitalized lease is for a ten-year period beginning December 31, 2002. Equal
annual payments of P100,000 are due on December 31 of each year, and the 14%
interest rate implicit in the lease known by Ginebra. The present value at December
31, 2004 of the seven remaining lease payments (due December 31, 2005 through
December 31, 2011) discounted at 14% was P430,000.
c. Deferred income taxes are provided in recognition of timing differences between
financial and income tax reporting of depreciation. For the year ended December 31,
2005, depreciation per tax return exceeded book depreciation by P312,500.
Ginebra’s effective income tax rate for 2004 was 32%.
d. On July 1, 2005, Ginebra issued for P1,774,000, P2,000,000 face amount of its 10%,
P1,000 bonds. The Bonds were issued to yield 12%. The bonds are dated July 1,
2004 and will mature on July 1, 2014. Interest is payable annually on July 1. Ginebra
uses the interest method to amortize bond discount.
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1. Liability under finance lease as of December 31, 2005
a. P381,600 b. P390,200 c. P344,828 d. P330,000
2. Total noncurrent liabilities as of December 31, 2005
a. P5,610,440 b. P5,770,640 c. P5,931,328 d. P5,725,268
3. Current portion of long-term liabilities as of December 31, 2005
a. P1,445,372 b. P1,400,000 c. P1,500,000 d. P1,446,576
4. Accrued interest payable as of December 31, 2005
a. P484,440 b. P432,628 c. P532,628 d. P478,000
5. Total interest expense for the year 2005
a. P652,440 b. P707,068 c. P712,640 d. P699,760

PROBLEM NO. 8
Select the best answer for each of the following:

1. In auditing accounts payable, an auditor’s procedures most likely will focus primarily on
management’s assertion of
a. Existence or occurrence c. Completeness
b. Presentation and disclosure d. Valuation or allocation

2. An auditor performs a test to determine whether all merchandise for which the client was
billed was received. The population for this test consists of all
a. Merchandise received c. Canceled checks
b. Vendors’ invoices d. Receiving reports

3. The primary audit test to determine if accounts payable are valued properly is
a. Confirmation of accounts payable
b. Vouching accounts payable to supporting documentation
c. An analytical procedure
d. Verification that accounts payable was reported as a current liability in the balance
sheet.

4. Which of the following procedures is least likely to be performed before the balance sheet
date?
a. Observation of inventory c. Search for unrecorded liabilities

AP-5902
 Page 9 of 11

b. Testing of internal control over cash d. Confirmation of receivables

5. An audit assistant found a purchase order for a regular supplier in the amount of P5,500.
The purchase order was dated after receipt of goods. The purchasing agent had
forgotten to issue purchase order. Also a disbursement of P450 for materials did not have
a receiving report. The assistant wanted to select additional purchase orders for
investigation but was unconcerned about lack of receiving report. The audit director
should
a. Agree with the assistant because the amount of the purchase order exception was
considerably larger than the receiving report exception
b. Agree with the assistant because the cash disbursement clerk had been assured by
the receiving clerk that the failure to fill out a report didn’t happen very often.
c. Disagree with the assistant because two problems have an equal risk of loss
associated with them.
d. Disagree with the assistant because the lack of a receiving report has a greater risk
of loss associated with it.
6. When using confirmation to provide evidence about completeness assertion for accounts
payable, the appropriate population most likely is
a. Vendors with whom the entity has previously done business.
b. Amounts recorded in the accounts payable subsidiary ledger.
c. Payees of checks drawn in the month after the year end.
d. Invoices filed in the entity’s open invoice file.
7. Which of the following is a substantive test that an auditor is most likely to perform to
verify the existence and valuation of recorded accounts payable?
a. Investigating the open purchase order file to ascertain that pre-numbered purchase
orders are used and accounted for.
b. Receiving the client’s mail, unopened, for a reasonable period of time after year end
to search for unrecorded vendor’s invoices.
c. Vouching selected entries in the accounts payable subsidiary ledger to purchase
orders and receiving reports.
d. Confirming accounts payable balances with known suppliers who have zero
balances.
8. Only one of the following four statements, which compare confirmation of accounts
payable with suppliers and confirmation of accounts receivable with debtors is false. The
false statement is that
a. Confirmation of accounts receivable with debtors is a more widely accepted auditing
procedures than is confirmation of accounts payable with suppliers.
b. Statistical sampling techniques are more widely accepted in the confirmation of
accounts payable than in the confirmation of accounts receivable.
c. As compared with the confirmation of accounts receivable, the confirmation of
accounts payable will tend to emphasize accounts with zero balances at the
balance sheet date.
d. It is less likely that the confirmation request sent to the supplier will show the
amount owed than that request sent to the debtor will show the amount due.
9. When title to merchandise in transit has passed to the audit client the auditor engaged in
the performance of a purchase cut-off will encounter the greatest difficulty in gaining
assurance with respect to the
a. Quantity b. Quality c. Price d. Terms
10. Which of the following audit procedures is least likely to detect an unrecorded liability?
a. Analysis and recomputation of interest expense.
b. Analysis and recomputation of depreciation expense.
c. Mailing of standard bank confirmation forms.
d. Reading of the minutes of meetings of the board directors.
11. Unrecorded liabilities are most likely to be found during the review of which of the
following documents?
a. Unpaid bills c. Bills of lading

AP-5902
 Page 10 of 11

b. Shipping records d. Unmatched sales invoices

12. Which of the following audit procedures is best for identifying unrecorded trade accounts
payable?
a. Reviewing cash disbursements recorded subsequent to the balance sheet date to
determine whether the related payables apply to the prior period.
b. Investigating payables recorded just prior to and just subsequent to the balance
sheet date to determine whether they are supported by receiving reports.
c. Examining unusual relationships between monthly accounts payable balances and
recorded cash payments.
d. Reconciling vendors’ statement to the file of receiving reports to identify items
received just prior to the balance sheet date.
13. In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditor
is most interested in examining the purchase
a. Journal b. Requisitions c. Orders d. Invoices
14. Which of the following procedures relating to the examination of accounts payable could
the auditor delegate entirely to the client’s employees?
a. Test footings in the accounts payable ledger
b. Reconcile unpaid invoices to vendors statements
c. Prepare a schedule of accounts payable
d. Mail confirmations for selected account balances
15. An auditor’s purpose in reviewing the renewal of a note payable shortly after the balance
sheet date most likely is to obtain evidence concerning management’s assertions about
a. Existence or occurrence c. Completeness
b. Presentation and disclosure d. Valuation or allocation.
16. An auditor’s program to audit long term debt should include steps that require
a. Examining bond trust indentures
b. Inspecting the accounts payable subsidiary ledger.
c. Investigating credits to the bond interest income account.
d. Verifying the existence of the bondholders.
17. In an audit of bonds payable, an auditor expects the trust indenture to include the
a. Auditee’s debt-to-equity ratio at the time of issuance.
b. Effective yield of the bonds issued.
c. Subscription list.
d. Description of the collateral
18. In auditing long-term bonds payable, an auditor most likely will
a. Perform analytical procedures on the bond premium and discount accounts.
b. Examine documentation of assets purchased with bond proceeds or liens
c. Compare interest with the bond payable amount for reasonableness.
d. Confirm the existence of individual bondholders at year-end.
19. The audit procedures used to verify accrued liabilities differ from those employed for the
verification of accounts payable because
a. Accrued liabilities usually pertain to services of a continuing nature while accounts
payable are the result of completed transactions
b. Accrued liability balances are less material than accounts payable balances.
c. Evidence supporting accrued liabilities in nonexistence while evidence supporting
accounts payable is readily available.
d. Accrued liabilities at year-end will become accounts payable during the following
year.
20. The auditor is most likely to verify accrued commissions payable in conjunction with the
a. Sales cutoff test
b. Verification of contingent liabilities
c. Review of post balance sheet date disbursements
d. Examination of trade accounts payable

AP-5902
 Page 11 of 11

– End of AP-5902 –

AP-5902