Audit of PPE and intangible assets

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CEBU CPAR CENTER

M a n d a u e C I t y

AUDITING PROBLEMS

AUDIT OF PROPERTY, PLANT & EQUIPMENT AND INTANGIBLE ASSETS

PROBLEM NO. 1

The property, plant and equipment section of White Corporations 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 equipment6,600,000

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

Cash paid on purchase of landP10,000,000

Mortgage assumed on the land bought, including interest at 16%16,000,000

Realtors commission1,200,000

Legal fees, realty taxes and documentation expenses200,000

Amount paid to relocate persons squatting on the property400,000

Cost of tearing down an old building on the land 300,000

Amount recovered from the salvage of the building demolished600,000

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

Architects fee100,000

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 machines1,600,000

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

The following were discovered during your audit of Black Companys 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 companys 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 companys 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.

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 Blacks 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:

DateParticularsAmount

Jan. 31Land and buildingP 1,098,000

Feb. 28Cost of removal of old building60,000

May 02Partial payment on new construction700,000

02Legal fees paid15,000

June 01Second payment on new construction600,000

July 01Fire insurance premium 1 year26,000

01Final payment on new construction200,000

Dec. 31Asset write-up 500,000

P 3,199,000

Dec. 31Depreciation 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 incorporationP 9,500

Examination of title covering purchase of the land4,000

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.

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:

DateParticularsDebitCredit

2005

Jan. 01BalanceMachines 1, 2, 3, and 4 at P90,000 eachP 360,000

Aug 31Machine 5

Machine 1198,000

P 3,000

Sept 30Machine 696,000

Dec 01Machines 7 and 8 at P216,000 each432,000

Dec 01Machine 221,000

31Balance

. 1,062,000

P1,086,000P1,086,000

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

Machine 1P 84,375

Machine 239,375

Machine 333,750

Machine 4 22,500

TotalP 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.

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 companys financial statements.

Audited balances at December 31, 2004:

DebitCredit

Land

Buildings

Accumulated depreciation buildings

Machinery and equipment

Accumulated depreciation

Machinery and Equipment

Delivery Equipment

Accumulated Depreciation

Delivery EquipmentP 3,750,000

30,000,000

22,500,000

2,875,000P 6,577,500

6,250,000

2,115,000

Depreciation Data:

Depreciation MethodUseful Life

Buildings

Machinery and Equipment

Delivery Equipment

Leasehold Improvements 150% declining balance

Straight-line

Sum-of-the-years-digits

Straight-line25 years

10 years

4 years

-

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.

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

2. How much is the Accumulated depreciation Machinery and Equipment as of December 31, 2005?

a. P8,844,375b. P8,614,375c. P8,830,000d. P8,556,8753. How much is the Accumulated depreciation Delivery Equipment as of December 31, 2005?

a. P2,715,000b. P2,400,000c. P2,490,000d. 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 companys operations for first year of operations.

Tons mined800,000 tons

Tons sold 640,000 tons

Unit selling price per ton P4.40

Direct labor640,000

Miscellaneous mining overhead128,000

Operating expenses (excluding depreciation)576,000

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. P1,689,600b. P1,753,600c. P1,702,400d. P1,672,533

5. How much is the maximum amount that may be declared as dividends at the end of the companys first year of operations?

a. P1,494,400b. P1,289,600c. P1,302,400d. P1,319,467

PROBLEM NO. 7

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

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

15Hired 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. 1Patented a newly developed process with costs as follows:

Legal fees to obtain patentP 429,000

Patent application and licensing fees 63,500

TotalP 492,500

It is estimated that in 6 years other companies will have developed improved processes, making the Pink Corporation process obsolete.

May 1Acquired 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 Pinks 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.

July 1Constructed a shed for P1,310,000 to house prototypes of experimental models to be developed in future research projects.

Dec. 31Incurred 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. P2,477,604c. P697,604

d. P0

5. Total amount resulting from the foregoing transactions that should be expensed when incurred

a. P4,100,500b. P1,983,000c. P1,998,000d. 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 Silvers 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:

Book valuesFair values

Identifiable assetsP2,700,000P3,000,000

Goodwill1,500,000?

Liabilities1,800,0001,800,000

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

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 managements 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.

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 expense12. 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 managements financial statement assertion of

a. Valuation.

c.Completeness.

b. Existence or occurrence.

d.Rights and obligations.

End of AP-5903

AP-5903