PrEA 6: Auditing and Assurance: Concepts and Application

Module 1 Activity: Audit of Property Plant and Equipment

Prepared by: Deborah Vasquez

Problem 1: Correcting Entries

The following are PPE acquisitions for selected companies:

1. FRENCH HORN COMPANY acquired land, buildings, and equipment from a financially distressed
company, Bankrupt Corp., for a lump sum price of P2,800,000. On the acquisition date, Bankrupt’s
assets had the following book and fair values:

Book Values Fair Values

Land 800,000.00 600,000.00
Buildings 1,000,000.00 1,400,000.00
Equipment 12,000,000.00 1,200,000.00

French Horn decided to take a conservative position by recording the lower of the two values for each
PPE item acquired. The following entry was made:

Land 600,000.00
Buildings 1,000,000.00
Equipment 1,200,000.00
Cash 2,800,000.00

2. TRUMPET, INC. purchased factory equipment by making a P200,000 cash down payment and
signing a 3-year P300,000, 10% note payable. The acquisition was recorded as follows:

Factory equipment 530,000.00

Cash 200,000.00
Note payable 300,000.00
Interest payable 30,000.00

3. TUBA CO. purchased store equipment for P800,000, terms 2/10, n/30. The company took the
discount and made the following entry when it paid for the acquisition:

Store equipment 800,000.00

Cash 784,000.00
Purchase discount 16,000.00
 4. FLUTE CORP. constructed a building at a total cost of 43,000,000. The building could have been
purchased for P45,000,000, The company’s controller made the follow, entry:

Building 45,000,000.00
Cash 43,000,000.00
Profit on construction 2,000,000.00

Required: Prepare the necessary correcting entry for each acquisition and brief discussion of your audit
findings.

Problem 2: Acquisition of PPE Items

The following items are included in the PPE section of the audited statement of financial position of
DRUMS CORP. as of December, 31 2015:

Land 3,450,000.00
Buildings 13,350,000.00
Leasehold improvements 9,900,000.00
Machinery and equipment 13,125,000.00

The following transactions occurred during 2016:

1. Land A was acquired for P12,750,000. In connection with the acquisition, Drums paid a P765,000
commission to a real estate agent. Costs of P525,000 were incurred to clear the land. During the
course of clearing the land, timber and gravel were recovered and sold for P195,000.
2. Land B with an old building was acquired for P7,500,000. On the acquisition date, the fair value of
the land was P4,200,000 and the fair value of the building was P1,800,000. The old building was
demolished at a cost of P615,000 shortly after acquisition. A new building to be used as an owner-
occupied property was constructed for P4,950,000 plus the following costs:

Excavation fees 570,000.00

Architectural design fees 165,000.00
Building permit fee 37,500.00
Imputed interest on funds used during
construction (stock financing) 127,500.00

The building was completed and occupied on December 30 2016.

3. Land C was acquired for P9,750,000 with the intention of selling it within 12 months from the date
of purchase.
4. During December 2016, costs of P1,335,000 were incurred to improve leased office space. The
related lease will terminate on December 31, 2018, and is not expected to be renewed.
5. A group of machines was purchased under a royalty agreement that provides for payment of
royalties based on units of production for the machines. The invoice price of the machines was
P1,305,000, freight costs were P49,500, installation costs were P36,000, and royalty payments for
2016 were P262,500

Based on the preceding information, determine the balances of the following PPE items as of December
31, 2016. State your audit findings.

Problem 3: Depreciations

FIDDLE COMPANY uses a large number of machines designed to Produce garments. These machines are
generally depreciated at 10% per annum on a straight-line basis. In general, machines are estimated to
have a residual value on disposal of 10% of cost. At January 1, 2016, Fiddle had a total of 73 machines,
and its statement of financial position showed a total cost of P1,260,000 and accumulated depreciation
of P390,000.

During 2016, the following transactions occurred:

 On March 1, 2016, a new machine was acquired for P45,000. This machine replaced two other
machines. One of the two replaced machines was acquired on January 1, 2013 for P24,600. It
was traded in on the new machine with Fiddler making a cash payment of P26,400 on the new
machine. The second replaced machine had cost P27,000 on October 1, 2013, and was sold for
P21,900.
 On July 1, 2016, a machine that had cost P12,000 on January 1, 2007, was retired from use and
sold for scrap for P1,500.
 On July 1, 2016, a machine that had been acquired on July 1, 2013, for P21,000 was repaired
because its motor had been damaged from overheating. The motor was replaced at a cost of
P14,400. It was expected that this would extend the life of the machine by an extra two years.
 On October 1, 2016, Fiddle fitted a new form of arm to a machine used for putting special
designs onto garments. The arm cost P3,600. The machine had been acquired on October 1,
2013, for P30,000. The arm can be used on a number of other machines when acquired and has
a 15-year life. It will not be sold when any particular machine is retired, but retained for use on
other machines.

Questions: (Show your solutions)

1. What amount of gain (loss) should be recognized on the sale of the second replaced machine on
March 1, 2016?
2. What amount of gain (loss) should be recognized on the machine sold for scrap on July 1, 2016?
3. What amount of depreciation should be provided in 2016 on the machine whose motor was
replaced on July 1, 2016?
4. What amount of depreciation should be provided in 2016 on the machine arm installed on
October 1, 2016?
5. 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.