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CEBU CPAR CENTERM a n d a u e C I t y

AUDITING PROBLEMS

COMPREHENSIVE PROBLEM

You were assigned to audit the financial statements of LARES Company for the year ended December 31, 2005. The fieldwork has been completed and you are now going over your audit findings to summarize your potential adjustments. The client is willing to accept all the necessary adjustments in order for the financial statements to be presented fairly in conformity with generally accepted accounting principles.

The following data were taken from your current working papers.

Cash account consists of the following items:

Petty cash fund P 10,000PBCom checking account (15,000)PNB current account 137,700 Total per GL P 132,700

a. The count of the cashier’s accountability on January 2, 2006, revealed total currency and coins of P3,600. Unreplenished vouchers for various expenses totaled P6,400, of which P1,200 pertains to January 2006.

b. On December 29, 2005, a check for P35,000 was drawn against PBCom current account resulting in bank overdraft of P15,000. The check was picked up by the supplier on January 3, 2006.

c. Bank reconciliation statement prepared by the cashier for the PNB account follows:

Bank balance P 124,200Add: Deposit in transit P 24,500 Bank service charges 500 25,000 Total 149,200Less: Outstanding checks Check No. Amount 567 P 1,000 @

589 8,300 617 2,400 626 3,400 11,500 Book balance P 137,700

@ Check certified by the bank in December 2005.

All reconciling items were traced to the bank statement. Further investigation indicated that the deposits in transit include a customer’s post-dated check amounting to P16,000. The check represents a collection from account customer for sales made in the middle of October 2005.

Your review of the client’s internal control points out many weaknesses. Accordingly, you did not perform tests of controls and you relied heavily on substantive procedures.

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Confirmation replies received directly from customers disclosed the following exceptions:

Confirmation No. Customer’s Comments Audit Findings5

(Mang Bert)The goods sold on December 1 were returned on December 16, 2005.

The client failed to record credit memo no. 23 for P12,000. The merchandise was included in the ending inventory at cost.

15(Mang Jess)

We do not owe this amount *%#@ (bad word). We did not receive any merchandise from your company.

Investigation revealed that goods sold for P16,000 were shipped to Mang Jess on December 29, 2005, terms FOB shipping point. The goods were lost in transit and the shipping company has acknowledged its responsibility for the lost of the merchandise.

21(Hercules)

I am entitled to a 10% employee discount. Your bill should be reduced by P1,200.

Hercules is an employee of LARES. Starting November 2005, all company employees were entitled to a special discount.

23(Eric)

We have not yet sold the goods. We will remit the proceeds as soon as the goods are sold.

Merchandise billed for P18,000 were consigned to Eric on December 30, 2005. The goods cost P13,000.

34(Mancio)

We do not owe you P20,000. We already paid our accounts as evidenced by OR # 1234.

The sale of merchandise on December 18, 2005 was paid by Mancio on January 6, 2006.

67(Jimmy)

Reduce your bill by P1,500 This amount represents freight paid by the customer for the merchandise shipped on December 17, 2005, terms, FOB destination-collect.

From the schedule of accounts receivable as of December 31, 2005, you determined that this account includes the following:

Accounts with debit balances: 60 days old and below P 238,500 61 to 90 days 117,200 Over 90 days 85,400 P 441,100Advances to officers 16,400Accounts with credit balance (15,000) Accounts receivable per GL P 442,500

The credit balance in customer’s account represents collection from a customer whose account had been written-off as uncollectible in 2004.

Accounts receivable for more than a year totaling P21,000 should be written off.

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Based on your discussion with Eddie, LARES’ Credit Manager, you both agreed that an allowance for doubtful accounts should be maintained using the following rates:

60 days old and below 1%61 to 90 days 2%Over 90 days 5%

The client determines its ending inventory by conducting a physical count at December 31 of each year. Compilation of physical inventory disclosed that tag numbers 143, 144, and 145 were not included in the inventory list.

Further investigation revealed the following:

Tag No.143 200 units costing P8 per unit144 800 units costing P15 per unit. Goods are held on consignment from

Lareng Co.145 Cancelled tag

Your review of purchase transactions made a few days before and after December 31, 2005 revealed the following:

a. Merchandise costing P8,000 was received on January 3, 2006. The related invoice was received and recorded on January 5, 2006. The invoice showed that the shipment was made by the vendor on December 27, 2005; FOB destination.

b. Merchandise with a cost of P14,000 was received on December 31, 2005 and the invoice was not recorded. The invoice was discovered at the Purchasing Officer’s desk and was stamped “On Consignment” from Kolokoy Company.

c. Merchandise received on January 3, 2006 costing P17,000 was entered in the voucher register on the same day. Shipment was made by the vendor FOB shipping point on December 31, 2005.

An analysis of 2005 transactions affecting the Available-for-Sale Securities and related accounts follows:

Available-for-sale SecuritiesJan. 01 Balance P 240,000Jan. 02 Purchased 10,000 Super Co. common shares 250,000July 01 Purchased P100,000,12% face value Mighty Co.

bonds 100,000Sept. 08 Purchased 500 LARES Co.’s shares 6,000 Dec. 31 Balance P 596,000

a. The January 1 balance represents the cost of 10,000 shares of Super Co.’s common stock acquired on January 2, 2004.

b. On January 2, 2005, LARES purchased 10,000 additional shares of Super Co.’s common stock for P250,000 when the book value of Super’s stockholders’ equity was P2,500,000.

c. From Super Company’s financial statements, you were able to obtain the following information:

2004 2005Net income 100,000 250,000Dividends - 170,000

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There are no other stockholders’ equity transactions that transpired in 2004 or 2005 for Super Company other than the above information.

At the end of 2005, the Super Co.’s common share was selling at P26 per share while LARES Co.’s stock was selling at P15 per share.

d. Other income includes dividend of P34,000 received from Super Co. in 2005.

e. The client does not intend to hold Mighty bonds to maturity. The bonds pay interest semi-annually on July 1 and January 1. Maturity date is 4 years from the date of purchase. The Mighty bonds were selling at par at December 31, 2005.

Examination of the equipment and related accumulated depreciation account revealed the following:

E Q U I P M E N T01/01/2005 Balance P 640,00004/01/2005 Proceeds from sale of equipment (10,000)07/01/2005 Cash paid to acquire new equipment 70,00009/30/2005 Repair of equipment 5,000 12/31/2005 Balance P 705,000

Accumulated Depreciation01/01/2005 Balance P 340,00012/31/2005 Depreciation – 2005 141,000 12/31/2005 Balance P 481,000

a. On April 1, an equipment costing P50,000, with a carrying value of P20,000 on the date of sale was sold for P10,000.

b. Old equipment was traded-in for new equipment with a market value of P75,000. The old equipment was bought for P60,000. The carrying value of this equipment on January 1, 2005 was P5,000.

c. Annual depreciation is computed at 20%. Salvage values of equipment are immaterial.

Examination of subsequent disbursements revealed that expenses for telephone, electricity, and water in 2005 totaling P32,000 were not recorded in the books.

On November 2, 2005, LARES Company issued P400,000 face value bonds. The bonds, which will mature on January 1, 2010, pay interest of 12% every January 1. The bonds were issued to give the bondholders a 14% yield.

From the minutes of the board of directors’ meetings, you gathered the following information:

a. During the year 2005, the company issued 10,000 shares of its P10 par value common stock for P12 each. The entire amount was credited to the common stock account.

b. On December 31, 2005, the board of directors declared a 10% stock dividend to stockholders on record as of January 16, 2006 distributable on January 31, 2006.

Presented on the next page are the unadjusted balances taken from the working trial balance.

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LARES CompanyDecember 31, 2005

Debit Credit

Cash P132,700 Accounts receivable 442,500 Allowance for doubtful accounts P15,000 Interest receivable -Advances to officers and employees -Inventory 367,200 Available-for-sale securities 596,000 Investment in Associate -Equipment 705,000 Accumulated depreciation 481,000 Accounts payable 168,175 Accrued expenses 28,600 Bank overdraft -Customers’ credit balance -Interest payable -Bonds payable 416,000 Discount on bonds payable -Common stock, P10 par 670,000 Stock dividends distributable -Additional paid-in capital 80,000 Retained earnings 90,975 Treasury stocks -Net sales 1,053,500 Cost of sales 525,400 Other income 42,450Investment income -Operating expenses 276,900 Other expenses -Finance cost - .

P3,045,700 P3,045,700

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INSTRUCTIONS: Select the best answer from choices: A, B, C, and D that corresponds to the audited balance of the account or account classification. Disregard tax implications.

A B C D 1 Cash 146,000 144,400 147,400 143,400 2 Accounts receivable 424,400 387,400 418,400 403,400 3 Allowance for doubtful accounts 12,952 8,958 9,000 7,942 4 Interest receivable 12,000 5,975 11,975 6,000 5 Advances to officers and employees 20,000 16,400 2,600 19,000 6 Inventory 367,800 353,200 371,800 384,800 7 Available-for-sale securities - 106,000 590,000 100,0008 Investment in associate - 490,000 506,000 516,0009 Equipment 700,000 600,000 705,000 605,000 10 Accumulated depreciation 451,000 401,000 431,000 371,000 11 Total assets 1,785,658 1,779,658 1,793,658 1,798,65812 Accounts payable 168,175 212,175 185,175 220,17513 Accrued expenses 32,000 28,600 26,800 60,600 14 Bank overdraft 35,000 15,000 20,000 - 15 Customers' credit balance 15,000 16,400 10,000 - 16 Interest payable 48,960 48,800 48,773 48,000 17 Bonds payable 376,000 416,000 376,960 400,000 18 Discount on bonds payable - 24,000 23,040 23,227 19 Total liabilities 670,548 697,548 657,548 705,54820 Common stock, P10 par 670,000 645,000 550,000 650,000 21 Stock dividends distributable 65,000 97,500 96,750 64,500 22 Additional paid-in capital 100,000 80,000 122,250 132,250 23 Retained earnings, 1/1/2005 111,975 112,975 90,975 100,975 24 Retained earnings, 12/31/2005 242,360 239,360 233,360 252,360 25 Treasury stock - 4,500 5,000 6,000 26 Total stockholders’ equity 1,088,110 1,080,110 1,074,110 1,093,11027 Net sales 1,023,500 1,034,300 1,040,300 1,022,300 28 Cost of sales 523,800 537,800 510,600 524,800 29 Other income 69,450 13,450 8,450 19,45030 Investment income - 49,000 48,000 50,000 31 Operating expenses 318,815 321,100 298,542 300,04232 Other expenses - 18,773 40,000 10,00033 Finance cost 8,000 48,773 48,000 8,773 34 Net income 235,135 229,135 243,135 248,13535 Cash shortage 1,200 3,600 - 2,600 36 Petty cash fund 6,400 3,600 5,200 4,800 37 Depreciation expense 122,000 141,000 123,500 121,000 38 Bond discount amortization - 800 960 773 39 Implied goodwill 40,000 10,000 20,000 -

40. Based on the above and the result your audit, you will most likely issuea. Unqualified opinion with explanatory paragraphb. Qualified or disclaimer of opinionc. Qualified or adverse opiniond. Unqualified opinion.

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