UNIVERSITY OF THE VISAYAS

APPLIED AUDITING
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.

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

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

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. 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
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. Unrecorded liabilities are most likely to be found during the review of which of the following documents?
a. Unpaid bills c. Bills of lading
b. Shipping records d. Unmatched sales invoices
9. 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.