AUDIT OF LIABILITIES – 2nd SET

Problem 1
On January 1, 2019, LACEA COMPANY issued 7% term bonds with a face amount of
P1,000,000 due January 1, 2027. Interest is payable semiannually on January 1 and July 1.
On the date of issue, investors were willing to accept an effective interest of 6%.

Questions

1. The bonds were issued on January 1, 2019 at

a. A premium c. Book value
b. An amortized value d. A discount

2. Assume the bonds were issued on January 1, 2019, for P1,062,809. Using the effective
interest amortization method, LACEA COMPANY recorded interest expense for the 6
months ended June 30, 2019, in the amount of

3. Same information in number 2. LACEA COMPANY recorded interest expense for the 6
months ended December 31, 2019, in the amount of

4. The carrying value of the bonds on July 1, 2020 is:

5. A bond issue sold at a premium is valued on the statement of financial position at the
a. Maturity value.
b. Maturity value plus the unamortized portion of the premium.
c. Cost at the date of investment.
d. Maturity value less the unamortized portion of the premium.

Problem 2
The following data were obtained from the initial audit of Popoy Company:

Debit Credit Balance

15%, 10-year Bonds Payable, dated
January 1, 2016.
Cash proceeds from issue on January 1,
2017 of 500, P1,000 bonds 522,500 522,500

Bonds Interest Expense

Cash paid – Jan. 2, 2018 37,500 37,500
Cash paid – July 1, 2018 37,500 75,000
Accrual – December 31, 2018 37,500 112,500

Accrued Interest on Bonds

Balance – Jan. 1, 2018 37,500 37,500
Accrual – Dec. 31 2018 37,500 75,000

Treasury Bonds
Redemption price and interest to date
on 100 bonds permanently retired –
October 1, 2018 109,000 109,000
Questions
1. What should be the correct original entry to account for the issuance of bonds at January
1, 2017?
DEBIT CREDIT
a. Cash 522,500 Bonds Payable 500,000
Discount on BP 22,500
b. Cash 500,000 Bonds Payable 500,000
c. Cash 522,500 Bonds Payable 500,000
Premium on BP 22,500
d. Cash 522,500 Bonds payable 522,500

2. The adjusting entry to accrue interest on bonds payable at December 31, 2017?
DEBIT CREDIT
a. Cash 37,500 Interest income 37,500
b. Interest expense 37,500 Interest payable 37,500
c. Interest receivable 37,500 Interest income 37,500
d. Interest expense 37,500 Interest income 37,500

3. The reversing entry related to accrual on bond interest expense at January 1, 2018?
DEBIT CREDIT
a. Interest income 37,500 Cash 37,500
b. Interest payable 37,500 Interest expense 37,500
c. Interest payable 37,500 Retained earnings 37,500
d. Retained earnings 37,500 Interest expense 37,500

4. The journal entry to record payment of interest due on July 1, 2018?

DEBIT CREDIT
a. Cash 37,500 Interest payable 37,500
b. Interest payable 37,500 Cash 37,500
c. Interest receivable 37,500 Cash 37,500
d. Interest expense 37,500 Cash 37,500

5. The reversing entry related to accrual on bond interest expense at January 1, 2019?
DEBIT CREDIT
a. Interest income 37,500 Cash 37,500
b. Interest payable 30,000 Interest expense 30,000
c. Interest payable 15,000 Interest expense 15,000
d. Interest income 37,500 Interest expense 37,500

6. The adjusting entry that should have been made to amortize on bond premium at
December 31, 2017?
DEBIT CREDIT
a. Premium on BP 2,500 Interest expense 2,500
b. Premium on BP 2,500 Retained earnings 2,500
c. Premium on BP 2,250 Interest expense 2,250
d. Premium on BP 2,250 Retained earnings 2,250

7. The correcting entry to adjust for the error related to amortization on bond premium in
2018 is?
DEBIT CREDIT
a. Premium on BP 2,500 Retained earnings 2,500
b. Premium on BP 2,500 Interest expense 2,500
c. Premium on BP 4,875 Interest expense 2,375
 Retained earnings 2,500
d. Premium on BP 4,875 Retained earnings 4,875

8. The correct entry to record retirement of 100 bonds on October 1, 2018?

a. Interest expense 3,750 Cash 109,000
Bonds payable 100,000
Premium on BP 3,625
Loss on retirement 1,625
b. Interest expense 3,750 Cash 109,000
Bonds payable 100,000
Premium on BP 3,625
Retained earnings 1,625
c. Interest expense 3,750 Cash 109,000
Bonds payable 100,000
Premium on BP 3,713
Loss on retirement 1,537
d. Interest expense 3,750 Cash 109,000
Bonds payable 100,000

PROBLEM 3
When the LUAYON MANUFACTURING COMPANY was expanding its metal window division, it
did not have enough capital to finance the expansion. So, management sought and received
approval from the board of directors to issue bonds. The company planned to issue
P5,000,000 of 8 percent, five-year bonds in 2017. Interest would be paid on June 30 and
December 31 of each year. The bonds would be callable at 104, and each P1,000 bond would
be convertible into 30 shares of P10 par value common stock.

On January 1, 2017, the bonds were sold at 96 because the market rate of interest for similar
investment was 9 percent. The company decided to amortize the bond discount by using the
effective interest method.

On July 1, 2019, management called and retired half the bonds, and investors converted the
other half into common stock. As inducement, the company agrees to pay additional P100,000
to the holders of the convertible bonds.

Questions
1. Carrying value of the bonds at December 31, 2017 is:

2. Carrying value of the bonds at December 31, 2018 is:

3. Interest expense at December 31, 2018 is:

4. Carrying value of the bonds converted is:

5. Additional paid-in capital in the conversion of bonds is:

6. Carrying value of retired bonds is:

7. Loss on early retirement of bonds is:

8. Interest expense on the bonds at December 31, 2019 is:

9. The company should record gain or loss on conversion of:

PROBLEM 4
In connection with your firm’s annual examination of the December 31, 2019 financial
statements of the NUNEZA CORPORATION, your have been assigned the duty of auditing
long-term liabilities for the year ended December 31, 2019. In the course of performing your
work, you obtain the following evidence and information related to a new bond issue sold
during 2019:

1. NUNEZA floated a new issue of P800,000 par value, 15-year, 10 percent bonds during the
latter half of the second quarter of the year.

2. The new bond issue was dated July 1, 2019 and it was sold on that date for P689,872.
This price provided an effective interest rate on the bond issue of 12 percent.

3. Interest on a new bond issue was payable semiannually on January 1 and July 1.

4. NUNEZA paid P12,000 cash for printing, legal, and other fees in connection with the
issuance of the bonds.

5. The NUNEZA CORPORATION accounts related to this new bond reflect these bond
transactions as follows:
Bond Payable, 2019 Issue
CR 7/1/19 P 800,000

Unamortized Bond Discount, 2019 Bond Issue

CD 7/1/19 P110,128
CD 7/1/19 12,000 JV 12/31/19 P 4,070.93

Bond Interest Expense, 2019 Bond Issue

JV 12/31/19 P 4,070.93
VR 12/30/19 40,000.00

Questions
1. Amortization of bond issue cost is:

2. Amortization of bond discount is:

3. Carrying value of the bonds at year-end is:

4 The accrued interest expense at year-end is:

5. The recorded amortization of bond discount is overstated by:

6. The carrying value of the bond issue cost at year-end is:

PROBLEM 5
On July 1, 2019 Salem Corporation issued P2,000,000 of 7% bonds payable in 10 years. The
bonds pay interest semiannually. Each P1,000 bond includes a detachable stock purchase
right. Each right gives the bondholder the option to purchase for P30, one share of P1 par
value common stock at any time during the next 10 years. The bonds were sold for
P2,000,000. The value of the stock purchase rights at the time of issuance was P100,000.

Questions

1. How many warrants were issued?

2. If the bondholder will exercise all his rights, the additional paid-in capital will be

PROBLEM 6
In your initial audit of EMILIA CORP., you find the following ledger account balances.

12% Bonds Payable – maturity date, 1/1/2027

1/2/17 CR P5,000,000

Treasury Bonds
10/1/19 CD P1,100,000

Bond Discount
1/2/17 CD P 500,000

Bond Interest Expense

1/1/19 CD P 300,000
7/1/19 CD 300,000

The bonds were redeemed for permanent cancellation on October 1, 2019, at 107 plus accrued
interest.

Questions
1. Adjusted balance of bonds payable on December 31, 2019.

2. Adjusted balance of bond discount on December 31, 2019.

3. Bond interest expense for 2019.

4. Gain or loss on bond redemption.

PROBLEM 7
At December 31, 2016, the Core Corporation had the following liability and equity account balances:

11% Bonds payable, at face value P2,500,000

Premium on bonds payable 176,190
Common stock 4,000,000
Additional paid in capital 1,147,500
Retained earnings 1,232,500
Treasury stock, at cost 162,500

Transactions during 2017 and other information relating to the Corporation’s liability and equity
accounts were as follows:

The bonds were issued on December 31, 2005, for P2,689,000 to yield 10%. The bonds mature on
December 31, 2022. Interest is payable annually on December 31. The Corporation uses the effective
interest method to amortize bond premium.

At December 31, 2016, the corporation had 1,000,000 authorized shares of P10 par common stock.

On November 2, 2017, the Corporation borrowed P2,000,000 at 9%, evidenced by a note payable to
Premium Bank. The note is payable in five equal annual principal installments of P400,000. The first
principal and interest payment is due on November 2, 2018.

Questions
1. How much is the bond premium amortization for 2017?

2. What is the carrying value of the bonds payable on December 31, 2017?

3. How much is the 2017 interest expense on bonds payable?

4. What is the treasury stock balance on December 31, 2017?

5. What is the long-term portion of the note payable to bank as of December 31, 2017?

6. What is the 2017 total interest expense?