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CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila

AUDITING PROBLEMS

AUDIT OF PROPERTY, PLANT & EQUIPMENT AND INTANGIBLE ASSETS PROBLEM

NO. 1

The property, plant and equipment section of White Corporation’s balance sheet at
December 31, 2004 included the following items:

Land P 2,500,000
Land improvements 560,000
Building 3,600,000
Machinery and equipment 6,600,000

During 2005 the following data were available to you upon your analysis of the accounts:

Cash paid on purchase of land P10,000,000

Mortgage assumed on the land bought, including interest at 16% 16,000,000
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Amount paid to relocate persons squatting on the property 400,000
Cost of tearing down an old building on the land 300,000
Amount recovered from the salvage of the building demolished 600,000
Cost of fencing the property 440,000
Amount paid to a contractor for the building erected 8,000,000
Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000
Interest that would have been earned had the money used during the
period of construction been invested in the money market 600,000
Invoice cost of machinery acquired 8,000,000
Freight, unloading, and delivery charges 240,000
Customs duties and other charges 560,000
Allowances, hotel accommodations, etc., paid to foreign
technicians during instillation and test run of machines 1,600,000
Royalty payment on machines purchased (based on units produced
and sold) 480,000

REQUIRED:

Based on the above and the result of your audit, compute for the following as of December
31, 2005:
1. Land
2. Land improvements
3. Building
4. Machinery and equipment
5. Total depreciable property, plant and equipment

PROBLEM NO. 2

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The following were discovered during your audit of Black Company’s financial statements
for the year ended December 31, 2005:

a. On December 24, 2005, Black purchased an office equipment for P400,000, terms
2/5, n/15. No entry was made on the date of purchase. The same was paid on
December 31, 2005 and the accountant debited Office Equipment and credited cash
for P400,000.

b. Machine C, with a cash price of P128,000, was purchased on January 2, 2005. The
company paid P20,000 down and P10,000 for 12 months. The last payment was
made on December 30, 2005. Straight line depreciation, based on a five-year useful
life and no salvage value, was recorded at P28,000 for the year. Freight of P4,000 on
machine C was debited to the Freight in account.

c. Machine P with a cash selling price of P360,000 was acquired on April 1, 2005, in
exchange for P400,000 face amount of bonds payable selling at 94, and maturing on
April 1, 2015. The accountant recorded the acquisition by a debit to Machinery and a
credit to Bonds Payable for P400,000. Straight line depreciation was recorded based
on a five-year economic life and amounted to P54,000 for nine months. In the
computation of depreciation, residual value of P40,000 was used.

d. Machine A was acquired on January 22, 2005, in exchange for past due accounts
receivable of P140,000, on which an allowance of 20% was established at the end of
2004. The current fair value of the machine on January 22 was estimated at
P110,000. The machine was recorded by a debit to Machinery and a credit to
Accounts Receivable for P140,000. No depreciation was recorded on Machine A,
because it was not installed and never used in operations. On February 2, 2005,
Machine A was exchanged for 1,000 shares of the company’s outstanding capital
stock with market price of P105 per share. The Treasury Stock account was debited
for P140,000 with the corresponding credit to Machinery.

e. On December 29, 2005, the company exchanged 10,000 shares of Emong, Inc.
common stock, which Black was holding as an investment, for an equipment from De
Leon Corporation. The common stock of Emong, Inc., which had been purchased by
Black for P45 per share, had a quoted market value of P50 per share on the date of
exchange. The equipment had a market value of P470,000. The transaction was
recorded by a debit to Equipment and a credit to Investment in Emong, Inc.-Common
for P450,000.

f. On December 30, 2005, Machine M with a carrying amount of P120,000 (cost

P400,000) was exchanged for a similar asset with a fair value of P150,000. In
addition, Black paid P20,000 to acquire the new machine. The exchange, which
lacks commercial substance, was recorded by a debit to Machinery and a credit to
cash for P20,000.

g. Machine E was recorded at P102,000, which included the carrying amount of

P22,000 for an old machine accepted as a trade in, and cash of P80,000. The cash
price of Machine S was P90,000, and the trade in allowance was P10,000. This
transaction took place on December 31, 2005.

h. Ms. Beauty, the company’s president, donated land and building appraised at
P200,000 and P400,000, respectively, to the company to be used as plant site. The
company began operating the plant on September 30, 2005. The building is
estimated to have a useful life of 25 years. Since no money was involved, no journal
entry was made for the above transaction.

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i. On July 1, 2004, the national government granted a parcel of land located in Baliuag,
Bulacan to Black. On the date of grant, the land had a fair value of P2,000,000. The
grant required Black to construct a cold storage building on the site. Black finished
the construction of the building, which has an estimated useful life of 25 years, on
January 2, 2005. Black appropriately recorded the cost of the building of P4,000,000
(which include direct materials, direct labor, and indirect cost and incremental
overhead) but failed to provide depreciation in 2005. Unaware of the accounting
procedures for government grants, the company did not reflect the grant on its books.

REQUIRED:

As Black’s external auditor, you are required to prepare any necessary adjusting journal
entries as of December 31, 2005.

PROBLEM NO. 3

The Blue Corporation was incorporated on January 2, 2005, but was unable to begin
manufacturing activities until July 1, 2005 because the new factory facilities were not
completed until that date.

The “Land and Building” account at December 31, 2005 follows:

Date Particulars Amount

Jan. 31 Land and building P 1,098,000 Feb. 28 Cost of removal of old
building 60,000 May 02 Partial payment on new construction 700,000
02 Legal fees paid 15,000
June 01 Second payment on new construction 600,000 July 01 Fire
insurance premium – 1 year 26,000 01 Final payment on new
construction 200,000
Dec. 31 Asset write-up 500,000
P 3,199,000 Dec. 31 Depreciation – 2005, at 1% of account balance
31,990
P 3,167,010

You were able to gather the following during your audit:

a. To acquire land and building, the company paid P98,000 cash and 10,000 shares of its
9% cumulative preferred shares, P100 par value per share. The shares were then
selling at P120.

b. Legal fees covered the following:

Cost of incorporation P 9,500

Examination of title covering purchase of the land 4,000 Legal work in
connection with construction contract 1,500
P 15,000

c. Because of a general increase in construction costs after entering into the building
contract, the board of directors increased the value of the building by P500,000,
believing such increase is justified to reflect current market value at the time the
building was completed. Retained earnings was credited for this amount.

d. Estimated useful life of the building is 25 years.

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REQUIRED:

1. Prepare the necessary adjusting journal entries as of December 31, 2005.

2. Determine the adjusted balances of the following as of December 31, 2005:

a. Land and building
b. Land
c. Carrying value of building
d. Organization cost, net (presented under Noncurrent Assets)

PROBLEM NO. 4

In the audit of the books of Green Company for the year 2005, the following items and
information appeared in the Production Machines account of the auditee:
Date Particulars Debit Credit
2005
Jan. 01 Balance–Machines 1, 2, 3, and 4 at P90,000 each P 360,000
Aug 31 Machine 5 198,000
Machine 1 P 3,000
Sept 30 Machine 6 96,000
Dec 01 Machines 7 and 8 at P216,000 each 432,000
Dec 01 Machine 2 21,000
31 Balance . 1,062,000
P1,086,000 P1,086,000

The Accumulated Depreciation account contained no entries for the year 2005. The
balance on January 1, 2005 per your audit, was as follows:

Machine 1 P 84,375 Machine 2

39,375
Machine 3 33,750
Machine 4 22,500
Total P 180,000

Based on your further inquiry and verification, you noted the following:

1. Machine 5 was purchased for cash; it replaced Machine 1, which was sold on this
date for P3,000.

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2. Machine 2 was destroyed by the thickness of engine oil used leading to explosion on
December 1, 2005. Insurance of P21,000 was recovered. Machine 7 was to replace
Machine 2.

3. Machine 3 was traded in for Machine 6 at an allowance of P12,000; the difference

was paid in cash and charged to Production Machine account.

4. Depreciation rate is recognized at 25% per annum.

REQUIRED:

Determine the adjusted balance of the Production Machine as of December 31, 2005 and
Depreciation Expense for the year 2005.

PROBLEM NO. 5

You obtain the following information pertaining to Red Co.’s property, plant, and equipment
for 2005 in connection with your audit of the company’s financial statements.

Audited balances at December 31, 2004:

Depreciation Data:
Debit Credit
Land P 3,750,000
Depreciation Method Useful Life
Buildings 150% declining30,000,000
– balance 25 years
Accumulated
Machinery and
depreciation Straight-line
Equipment – buildings P106,577,500
years
Machinery
Delivery Equipment
and equipment Sum-of-the-years’-digits
22,500,000 4 years
Accumulated
Leasehold Improvements
depreciation – Straight-line -
Machinery and Equipment 6,250,000
Delivery Equipment 2,875,000
Accumulated Depreciation –
Delivery Equipment 2,115,000

Transaction during 2005 and other information are as follows:

a. On January 2, 2005, Red purchased a new truck for P500,000 cash and traded-in a
2-year-old truck with a cost of P450,000 and a book value of P135,000. The new
truck has a cash price of P600,000; the market value of the old truck is not known.

b. On April 1, 2005, a machine purchased for P575,000 on April 1, 2000 was destroyed
by fire. Red recovered P387,500 from its insurance company.

c. On May 1, 2005, cost of P4,200,000 were incurred to improve leased office premises.
The leasehold improvements have a useful life of 8 years. The related lease
terminates on December 31, 2011.

d. On July 1, 2005, machinery and equipment were purchased at a total invoice cost of
P7,000,000; additional cost of P125,000 for freight and P625,000 for installation were
incurred.

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e. Red determined that the delivery equipment comprising the P2,875,000 balance at
January 1, 2005, would have been depreciated at a total amount of P450,000 for the
year ended December 31, 2005.

The salvage values of the depreciable assets are immaterial. The policy of the Red Co. is
to compute depreciation to the nearest month.

QUESTIONS:

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

1. How much is the Accumulated depreciation – Buildings as of December 31, 2005?

a. P7,777,500 b. P7,982,850 c. P8,377,500 d. P7,103,700

2. How much is the Accumulated depreciation – Machinery and Equipment as of

December 31, 2005?
a. P8,844,375 b. P8,614,375 c. P8,830,000 d. P8,556,875

3. How much is the Accumulated depreciation – Delivery Equipment as of December

31, 2005?
a. P2,715,000 b. P2,400,000 c. P2,490,000 d. P2,805,000

4. How much is the Accumulated depreciation – Leasehold Improvements as of

December 31, 2005?
a. P420,000 b. P525,000 c. P350,000 d. P630,000

5. How much is the net gain (loss) from disposal of assets for the year ended December
31, 2005?
a. P100,000 b. (P35,000) c. P65,000 d. (P65,000)

PROBLEM NO. 6

In connection with your audit of the Josef Mining Corporation for the year ended December
31, 2005, you noted that the company purchased for P10,400,000 mining property
estimated to contain 8,000,000 tons of ore. The residual value of the property is
P800,000.

Building used in mine operations costs P800,000 and have estimated life of fifteen years
with no residual value. Mine machinery costs P1,600,000 with an estimated residual value
P320,000 after its physical life of 4 years.

Following is the summary of the company’s operations for first year of operations.

Tons mined 800,000 tons

Tons sold 640,000 tons
Unit selling price per ton P4.40
Direct labor 640,000
Miscellaneous mining overhead 128,000
Operating expenses (excluding depreciation) 576,000

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Inventories are valued on a first-in, first-out basis. Depreciation on the building is to be

allocated as follows: 20% to operating expenses, 80% to production. Depreciation on
machinery is chargeable to production.

QUESTIONS:

Based on the above and the result of your audit, answer the following: (Disregard tax
implications)

1. How much is the depletion for 2005?

a. P768,000 b. P960,000 c. P192,000 d. P1,040,000

2. Total inventoriable depreciation for 2005?

a. P400,000 b. P362,667 c. P384,000 d. P0

3. How much is the Inventory as of December 31, 2005?

a. P438,400 b. P422,400 c. P425,600 d. P418,133

4. How much is the cost of sales for the year ended December 31, 2005?
a. P1,689,600 b. P1,753,600 c. P1,702,400 d. P1,672,533

5. How much is the maximum amount that may be declared as dividends at the end of
the company’s first year of operations?
a. P1,494,400 b. P1,289,600 c. P1,302,400 d. P1,319,467

PROBLEM NO. 7

Transactions during 2005 of the newly organized Pink Corporation included the following:

Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to
complete organization of the corporation.

15 Hired a clown to stand in front of the corporate office for 2 weeks and
hound out pamphlets and candy to create goodwill for the new
enterprise. Clown cost, P10,000; pamphlets and candy, P5,000.

Apr. 1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P 429,000
Patent application and licensing fees 63,500
Total P 492,500

It is estimated that in 6 years other companies will have developed

improved processes, making the Pink Corporation process obsolete.

May 1 Acquired both a license to use a special type of container and a

distinctive trademark to be printed on the container in exchange for
6,000 shares of Pink’s no-par common stock selling for P50 per share.
The license is worth twice as much as the trademark, both of which may
be used for 6 years.

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July 1 Constructed a shed for P1,310,000 to house prototypes of experimental

models to be developed in future research projects.

Dec. 31 Incurred salaries for an engineer and chemist involved in product development
totaling P1,750,000 in 2005.

QUESTIONS:

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

1. Cost of patent
a. P492,500 b. P429,000 c. P63,500 d. P0

2. Cost of licenses
a. P150,000 b. P200,000 c. P100,000 d. P0

3. Cost of trademark
a. P150,000 b. P200,000 c. P100,000 d. P0

4. Carrying amount of Intangible Assets

a. P712,604 b. P2,477,604 c. P697,604 d. P0

5. Total amount resulting from the foregoing transactions that should be expensed when
incurred
a. P4,100,500 b. P1,983,000 c. P1,998,000 d. P0

PROBLEM NO. 8

On December 31, 2004, Silver Corporation acquired the following three intangible assets:

• A trademark for P300,000. The trademark has 7 years remaining legal life. It is
anticipated that the trademark will be renewed in the future, indefinitely, without
problem.

• Goodwill for P1,500,000. The goodwill is associated with Silver’s Hayo Manufacturing
reporting unit.

• A customer list for P220,000. By contract, Silver has exclusive use of the list for 5
years. Because of market conditions, it is expected that the list will have economic
value for just 3 years.

On December 31, 2005, before any adjusting entries for the year were made, the following
information was assembled about each of the intangible assets:

a) Because of a decline in the economy, the trademark is now expected to generate cash
flows of just P10,000 per year. The useful life of trademark still extends beyond the
foreseeable horizon.

b) The cash flows expected to be generated by the Hayo Manufacturing reporting unit is
P250,000 per year for the next 22 years. Book values and fair values of the assets and
liabilities of the Hayo Manufacturing reporting unit are as follows:

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Book values Fair values

Identifiable assets P2,700,000 P3,000,000
Goodwill 1,500,000 ?
Liabilities 1,800,000 1,800,000

c) The cash flows expected to be generated by the customer list are P120,000 in 2006
and P80,000 in 2007.

REQUIRED:

Based on the above and the result of your audit, determine the following: (Assume that the
appropriate discount rate for all items is 6%):

1. Total amortization for the year 2005

a. P73,333 b. P141,515 c. P116,190 d. P86,857

2. Impairment loss for the year 2005

a. P90,476 b. P133,333 c. P179,584 d. P0

3. Carrying value of Trademark as of December 31, 2005

a. P300,000 b. P257,143 c. P166,667 d. P120,416

4. Carrying value of Goodwill as of December 31, 2005

a. P1,500,000 b. P1,431,818 c. P1,425,000 d. P1,462,500

5. Carrying value of Customer list as of December 31, 2005

a. P220,000 b. P146,667 c. P176,000 d. P0

PROBLEM NO. 9

Select the best answer for each of the following:

1. Property, plant and equipment is typically judged to be one of the accounts least
susceptible to fraud because
a. The amounts recorded on the balance sheet for most companies are immaterial.
b. The inherent risk is usually low.
c. The depreciated values are always smaller than cost.
d. Internal control is inherently effective regarding this account.

2. Which is the best audit procedure to obtain evidence to support the legal ownership
of real property?
a. Examination of corporate minutes and board resolutions with regard to approvals
to acquire real property.
b. Examination of closing documents, deeds and ownership documents registered
and on file at the register of deeds.
c. Discussion with corporate legal counsel concerning the acquisition of a specific
piece of property.
d. Confirmation with the title company that handled the escrow account and
disbursement of proceeds for the closing of the property.

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3. When few property and equipment transactions occur during the year the continuing
auditor usually obtains and understanding of internal control and performs a. Tests of
controls
b. Analytical procedures to verify current year additions to property and equipment
c. A thorough examination of the balances at the beginning of the year.
d. Extensive tests of current year property and equipment transactions.

4. Which of the following combinations of procedures is an auditor most likely to perform

to obtain evidence about fixed asset addition?
a. Inspecting documents and physically examining assets.
b. Recomputing calculations and obtaining written management representations.
c. Observing operating activities and comparing balances to prior period balances.
d. Confirming ownership and corroborating transactions through inquiries of client
personnel.

5. If an auditor tours a production facility, which of the misstatements or questionable

practices is most likely to be detected by the audit procedures specified?
a. Depreciation expense on fully depreciated machinery has been recognized.
b. Overhead has been overapplied.
c. Necessary facility maintenance has not been performed.
d. Insurance coverage on the facility has lapsed.

6. In testing for unrecorded retirements of equipment, an auditor is most likely to

a. Select items of equipment from the accounting records and then locate them
during the plant tour.
b. Compare depreciation journal entries with similar prior-year entries in search of
fully depreciated equipment.
c. Inspect items of equipment observed during the plant tour and then trace them to
the equipment subsidiary ledger.
d. Scan the general journal for unusual equipment additions and excessive debits to
repairs and maintenance expense.

7. Determining that proper amounts of depreciation are expensed provides assurance

about management’s assertions of valuation and
a. Presentation and disclosure. c. Rights and obligations.
b. Completeness. d. Existence or occurrence.

8. The auditor may conclude that depreciation charges are insufficient by noting
a. Insured values greatly in excess of book values.
b. Large numbers of fully depreciated assets.
c. Continuous trade-in of relatively new assets.
d. Excessive recurring losses on assets retired.

9. An auditor analyzes repairs and maintenance accounts primarily to obtain evidence in

support of the audit assertion that all
a. Noncapitalizable expenditures for repairs and maintenance have been recorded in
the proper period.
b. Expenditures for property and equipment have been recorded in the proper
period.
c. Noncapitalizable expenditures for repairs and maintenance have been properly
charged to expense.
d. Expenditures for property and equipment have not been charged expense.

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10. In violation of company policy, Coatsen Company erroneously capitalized the cost of
painting its warehouse. An auditor would most likely detect this when a. Discussing
capitalization policies with Coatsen's controller.
b. Examining maintenance expense accounts.
c. Observing that the warehouse had been painted.
d. Examining construction work orders that support items capitalized during the year.

11. Additions to equipment are sometimes understated. Which of the following accounts
would be reviewed by the auditor to gain reasonable assurance that additions are not
understated?
a. Accounts payable c. Depreciation expense
b. Gain on disposal of equipment d. Repair and maintenance expense

12. When an auditor interviews the plant manager, he will most likely seek from the plant
manager information regarding
a. Appropriateness of physical inventory observation procedures.
b. Existence of obsolete machinery.
c. Deferral of procurement of certain necessary insurance coverage.
d. Adequacy of the provision for uncollectible accounts.

13. The auditor is least likely to learn of retirements of equipment through which of the
following?
a. Review of the purchase return and allowance account.
b. Review of depreciation.
c. Analysis of the debits to the accumulated depreciation account.
d. Review of insurance policy riders.

14. Which of the following is not likely a motive for management to manipulate the timing
and amount of impaired asset writedowns?
a. Steady increases in earnings per share over the past 5 years.
b. Income smoothing.
c. A "big bath."
d. An abnormally unprofitable year.

15. There is goodwill involved in the acquisition of a business if the purchase price paid is
in excess of the proprietorship of the business acquired.

Goodwill might be viewed as the enjoyment of a profit by a company in excess of the

normal or usual return for the industry as a whole but such goodwill is not recorded if
it has not been purchased or paid for.
a. False; True. c. True; False.
b. False; False. d. True; True.

16. In auditing intangible assets, an auditor most likely would review or recompute
amortization and determine whether the amortization period is reasonable in support
of management’s financial statement assertion of
a. Valuation. c. Completeness.
b. Existence or occurrence. d. Rights and obligations.

– End of AP-5903 –

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AVERAGE
1. Gehrig Corporation renewed an insurance policy for 3 years beginning July 1,
2007 and recorded the P81,000
premium in the prepaid insurance account. The P81,000 premium represents an
increase of P23,400 from the
P57,600 premium charged 3 years ago. Assuming Gehrig’s records its insurance
adjustments only at the end of the
calendar year, the adjusting entry required to reflect the proper balances in the
insurance accounts at December 31,
2007, Gehrig’s year-end is to
a. Debit insurance expense for P13,500 and credit prepaid insurance for P13,500.
b. Debit prepaid insurance for P13,500 and credit insurance expense for P13,500
c. Debit insurance expense for P23,100 and credit prepaid insurance for P23,100.
d. Debit insurance expense for P67,500 and credit prepaid insurance for P67,500

3. Prepaid insurance at year-end is:

a. P 450,000 b. P 325,000 c. P 125,000 d. P 0

3. Interest income 25,500

Interest receivable 25,500
To reverse accrued income.
Interest receivable 21,750
Interest income 21,750

450,000- 125,000

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