AUDIT OF LIABILITIES

SUBSTANTIVE AUDIT OF LIABILITIES

Existence: Recorded liabilities exist Rights and obligations: Liabilities are owed by the entity
1. Obtain from the client a listing of accounts and notes 8. Confirm recorded liabilities directly with suppliers and
payable as of year-end and reconcile to the general creditors.
ledger.
9. Review documentation in client’s files.
2. Vouch recorded liabilities to the suppliers’ statements.
10. Examine subsequent payments to credits.
3. Confirm recorded liabilities directly with suppliers and
creditors. Investigate differences in liabilities reported
in the confirmations with the recorded book amounts. Valuation and allocation: Liabilities are valued in
accordance with GAAP
4. Examine bank confirmations for loans.
11. Vouch accounts payable schedule.

12. Test computation of accrued or prepaid interest.

Completeness: All liabilities are recorded
5. Perform purchases cutoff examination.
Presentation and disclosure: Liabilities are classified and
6. Test for unrecorded liabilities. disclosed in accordance with GAAP
13. Review financial statements and perform analytical
7. Perform analytical procedures.
procedures to determine whether accounts are
classified and disclosed in the financial statements in
accordance with GAAP.

INTERNAL CONTROL MEASURES

Current Liabilities
Accounts payable
1. A proper system of requisitioning, purchase order placement and approval, receiving, invoice approval, and approval
for payment should be well-defined and established.
2. Subsidiary accounts payable records or unpaid vouchers should be reconciled with controlling account at frequent
intervals.
3. Check mathematical accuracy of suppliers’ invoices prior to recording.
4. Adjustments to accounts payable should be properly approved.
5. Debit balances in accounts payable should be reviewed and resolved.

Notes payable
1. Borrowings on notes payable should be properly authorized. (Specify the institutions from which money may be
borrowed and designate the officers authorized to sign notes)
2. Unissued notes should be properly safeguarded.
3. Adequate and well organized records for notes specifying the details should be maintained.
4. Subsidiary notes payable records should be reconciled with controlling account at frequent intervals.
5. Paid notes should be properly cancelled and preserved.

Long-Term Liabilities
1. Long-term obligation should be properly authorized by the board of directors or by a required majority of the
shareholders.
2. There should be proper control over issued and unissued obligations as in bonds, by an independent bond trustee or
transfer agent.
3. Redeemed bonds should be cancelled, property mutilated and retained for audit in order to prevent the unauthorized
issuance.
4. Bond ledger should be used in which details of bonds issued, cancelled and outstanding are shown. A subsidiary
bondholders’ ledger should also be maintained by the issuing corporation or the bond trustee for bonds registered, as
to principal and interest.
5. Proper control should be exercised over the payment of interest on long-term liabilities. Payment may be done by an
independently engaged interest-paying agent.

- end -

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PROBLEM NO. 1 5. In auditing accounts payable, an auditor’s procedures
most likely will focus primarily on management’s
Dallas Corporation is selling audio and video appliances.
assertion of
The company’s fiscal year ends on March 31. The
a. Existence c. Completeness
following information relates to the obligations of the
b. Presentation and disclosure d. Valuation
company as of March 31, 2020:
6. Which of the following procedures is least likely to be
Notes payable
performed before the balance sheet date?
Dallas has signed several notes with financial institutions.
a. Observation of inventory
The maturities of these notes are given below. The total
b. Testing of internal control over cash
unpaid interest for all of these notes amounts to P340,000
c. Search for unrecorded liabilities
on March 31, 2020.
d. Confirmation of receivables
Due date Amount
April 31, 2020 P 700,000 7. Unrecorded liabilities are most likely to be found during
July 31, 2020 900,000 the review of which of the following documents?
February 1, 2021 800,000 a. Unpaid bills
April 30, 2021 1,200,000 b. Bills of lading
June 30, 2021 1,500,000 c. Shipping records
P 5,100,000 d. Unmatched sales invoices

Estimated warranties 8. An auditor’s purpose in reviewing the renewal of a note

Dallas has a one-year product warranty on some selected payable shortly after the balance sheet date most
items. The estimated warranty liability on sales made likely is to obtain evidence concerning management’s
during the 2018 – 2019 fiscal year and still outstanding as assertions about
of March 31, 2019, amounted to P252,000. The warranty a. Existence or occurrence
costs on sales made from April 1, 2019 to March 31, 2020, b. Presentation and disclosure
are estimated at P630,000. The actual warranty costs c. Valuation or allocation
incurred during 2019 – 2020 fiscal year are as follows: d. Completeness
Warranty claims honored on
2018 – 2019 sales P 252,000
Warranty claims honored on PROBLEM NO. 2
2019 – 2020 sales 285,000
Relevant extracts from Magic Corporation’s financial
Total P 537,000
statements at 31 December 2019 are as follows:
Trade payables Current liabilities
Accounts payable for supplies, goods, and services Provision for warranties P405,000
purchases on open account amount to P560,000 as of
March 31, 2020. Non-current liabilities
Provision for warranties 270,000
Dividends
On March 10, 2020, Dallas’ board of directors declared a Note 10 - Contingent liabilities
cash dividend of P0.30 per ordinary share and a 10% Magic is engaged in litigation with various parties
ordinary share dividend. Both dividends were to be in relation to allergic reactions to traces of peanuts
distributed on April 5, 2020 to ordinary shareholders on alleged to have been found in packets of fruit
record at the close of business on March 31, 2020. As of gums. Magic strenuously denies the allegations
March 31, 2020, Dallas has 5 million, P2 par value, and, as at the date of authorizing the financial
ordinary shares issued and outstanding. statements for issue, is unable to estimate the
financial effect, if any, of any costs or damages
Bonds payable that may be payable to the plaintiffs.
Dallas issued P5,000,000, 12% bonds, on October 1, 2014
at 96. The bonds will mature on October 1, 2024. The provision for warranties at 31 December 2019 was
Interest is paid semi-annually on October 1 and April 1. calculated using the following assumptions: There was no
Dallas uses the straight line method to amortize bond balance carried forward from the prior year.
discount. Estimated costs of repairs - products with
minor defects P1,500,000
QUESTIONS:
Estimated cost of repairs - products with
Based on the foregoing information, determine the major defects P9,000,000
adjusted balances of the following as of March 31, 2020: Expected % of products sold during 2019
having no defects in 2020 80%
1. Estimated warranty payable Expected % of products sold during 2019
a. P252,000 c. P630,000 having minor defects in 2020 15%
b. P345,000 d. P882,000 Expected % of products sold during 2019
2. Total current liabilities having major defects in 2020 5%
a. P6,445,000 c. P5,445,000 Expected timing of settlement of warranty
b. P5,105,000 d. P3,945,000 payments - those with minor defects All in 2020
Expected timing of settlement of warranty 40% in
3. Trade and other payables payments - those with major defects 2020, 60%
a. P5,445,000 c. P3,045,000 in 2021
b. P5,100,000 d. P2,700,000
4. Total noncurrent liabilities During the year ended 31 December 2020 the following
a. P7,700,000 c. P7,590,000 occurred:
b. P7,500,000 d. P7,610,000 1. In relation to the warranty provision of P675,000 at 31
December 2019, P300,000 was paid out of the

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 provision. Of the amount paid, P225,000 was for
products with minor defects and P75,000 was for
products with major defects, all of which related to
5. Total provisions to be reported in the statement of
amounts that had been expected to be paid in 2020.
financial position as of December 31, 2020 is
2. In calculating its warranty provision for 31 December a. P 720,000 c. P 615,000
2020, Magic made the following adjustments to the b. P1,770,000 d. P2,040,000
assumptions used for the prior year:
Estimated cost of repairs - products
with minor defects No change PROBLEM NO. 3
Estimated cost of repairs - products In your initial audit of Bulls Co., you find the following
with major defects P7,500,000 ledger account balances.
Expected % of products sold during
2020 having no defects in 2021 85% 12%, 25-year Bonds Payable, 2016 issue
Expected % of products sold during 01/01/201 CR P 1,600,000
2020 having minor defects in 2021 13% 6
Expected % of products sold during
2020 having major defects in 2021 2% Treasury Bonds
Expected timing of settlement of
10/01/202 CD P 216,000
warranty payments - those with
0
minor defects All in 2021
Expected timing of settlement of 20% in
Bond Premium
warranty payments - those with 2021, 80%
01/01/2016 CR P 80,000
major defects in 2022
3. Magic determined that part of its plant and equipment
Bond Interest Expense
needed an overhaul – the conveyer belt on one of its
01/01/2020 CD P 96,000
machines would need to be replaced in about
07/01/2020 CD 96,000
December 2021 at an estimated cost of P500,000.
The carrying amount of the conveyer belt at 31
December 2020 was P280,000. Its original cost was The bonds were redeemed for permanent cancellation on
P400,000. October 1, 2020 at 105 plus accrued interest.
4. Magic was unsuccessful in its defense of the peanut
QUESTIONS:
allergy case and was ordered to pay P2,000,000 to the
plaintiffs. As at 31 December 2020 Magic had paid Based on the above and the result of your audit, answer
P1,500,000. the following: (Use straight line amortization method)
5. Magic commenced litigation against one of its advisers 1. The adjusted balance of bonds payable as of December
for negligent advice given on the original installation of 31, 2020 is
the conveyers’ belt referred to in (4) above. In a. P1,400,000 c. P1,600,000
October 2020 the court found in favor of Magic. The b. P1,000,000 d. P1,384,000
hearing for damages had not been scheduled as at the
date the financial statements for 2020 were authorized 2. The unamortized bond premium on December 31,
for issue. Magic estimated that it would receive about 2020 is
P500,000. a. P80,000 c. P64,000
b. P56,000 d. P58,800
6. Magic signed an agreement with Choko Bank to the
effect that Magic would guarantee a loan made by 3. The total bond interest expense for the year 2020 is
Choko Bank to Magic's subsidiary, UN Ltd. UN’s Ltd. a. P189,100 c. P182,900
loan with Choko Bank was P3,000,000 as at 31 b. P188,800 d. P182,800
December 2020. UN Ltd. was in a strong financial 4. The gain or loss on partial bond redemption is
position at 31 December 2020. a. P1,900 loss c. P1,900 gain
b. P18,100 loss d. P18,100 gain
QUESTIONS:
Based on the above and the result of your audit, answer 5. An auditor’s program to audit long term debt should
the following: include steps that require
a. Examining bond trust indentures
1. The warranty expense in 2020 is b. Inspecting the accounts payable subsidiary ledger.
a. P150,000 c. P600,000 c. Investigating credits to the bond interest income
b. P240,000 d. P345,000 account.
d. Verifying the existence of the bondholders.
2. The provision for warranties as of December 31, 2020
is
6. In an audit of bonds payable, an auditor expects the
a. P870,000 c. P345,000
trust indenture to include the
b. P720,000 d. P615,000
a. Auditee’s debt-to-equity ratio at the time of
3. The provision for warranties to be reported as current issuance.
liability as of December 31, 2020 is b. Effective yield of the bonds issued.
a. P330,000 c. P225,000 c. Subscription list.
b. P600,000 d. P495,000 d. Description of the collateral
4. The provision for warranties to be reported as 7. In auditing long-term bonds payable, an auditor most
noncurrent liability as of December 31, 2020 is likely will
a. P120,000 c. P390,000 a. Perform analytical procedures on the bond
b. P225,000 d. P495,000 premium and discount accounts.

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 b. Examine documentation of assets purchased with 31 December 2020 P8,000
bond proceeds or liens Fair value of the machine at 1
c. Compare interest with the bond payable amount January 2020 P34,797
for reasonableness. Estimated economic life of the
d. Confirm the existence of individual bondholders at machine 8 years
year-end. Estimated residual value of the asset
at the end of its economic life P2,000
8. Which of the following audit procedures is least likely Residual value at the end of the lease
to detect an unrecorded liability? term, of which 50% is guaranteed
a. Analysis and recomputation of interest expense. by Lessee Corporation P7,200
b. Mailing of standard bank confirmation forms. Interest rate implicit in the lease ?
c. Reading of the minutes of meetings of the board
directors. The lease is cancellable, but a penalty equal to 50% of the
d. Analysis and recomputation of depreciation total lease payments is payable on cancellation. Lessee
expense. Corporation does not intend to buy the machine at the end
of the lease term, Jackie Corporation incurred P1,000 to
negotiate and execute the lease agreement. Jackie
PROBLEM NO. 4 Corporation purchased the machine for P34,797 just
before the inception of the lease.
On January 1, 2019, Thunder Corporation issued 2,000
of its 5-year, P1,000 face value, 11% bonds dated January
QUESTIONS:
1 at an effective annual interest rate (yield) of 9%.
Interest is payable each December 31. Thunder uses the Based on the above and the result of your audit, answer
effective interest method of amortization. On December the following: (Round off present value factors to four
31, 2020, the 2,000 bonds were extinguished early decimal places)
through acquisition in the open market by Thunder for
1. The interest rate implicit in the lease is
P1,980,000 plus accrued interest.
a. 6% c. 8%
b. 7% d. 9%
On July 1, 2019, Thunder issued 5,000 of its 6-year,
P1,000 face value, 10% convertible bonds at par. Interest 2. Ignoring income taxes, if Jackie Corporation
is payable every June 30 and December 31. On the date erroneously accounted for the transaction as an
of issue, the prevailing market interest rate for similar debt operating lease, its profit for 2020 will be overstated
without the conversion option is 12%. On July 1, 2020, an by
investor in Thunder’s convertible bonds tendered 1,500 a. P478 c. P 678
bonds for conversion into 15,000 ordinary shares of b. P553 d. P1,128
Thunder, which had a fair value of P105 and a par value of
P1 at the date of conversion. 3. The amount to be reported by Lessee Corporation as
lease liability under current liabilities as of 31
QUESTIONS: December 2020 is
a. P5,208 c. P5,709
Based on the above and the result of your audit, determine b. P5,438 d. P6,223
the following: (Round off present value factors to four
decimal places.) 4. The depreciation amount to be recognized by Lessee
Corporation for the year ended 31 December 2020 is
1. The issue price of the 2,000 5-year, P1,000 face value a. P5,971 c. P3,932
bonds on January 1, 2019 is b. P5,251 d. P6,291
a. P2,155,534 c. P2,000,000
b. P1,844,434 d. P2,147,800 5. Ignoring income taxes, if Lessee Corporation
erroneously accounted for the transaction as an
2. The carrying amount of the 2,000 5-year, P1,000 face operating lease, its profit for 2020 will be overstated
value bonds on December 31, 2019 is by
a. P1,898,434 c. P2,000,000 a. P1,513 c. P1,193
b. P2,129,534 d. P2,121,100 b. P1,302 d. P 982
3. The gain on early retirement of bonds on December
PROBLEM NO. 6
31, 2020 is
a. P 20,000 c. P121,286 Roy Ltd has determined its accounting profit before tax for
b. P112,000 d. P 0 the year ended 30 June 2020 to be P256,700. Included in
this profit are the items of income and expense shown
4. The issuance of the 6-year, P1,000 face value bonds
below.
on July 1, 2019 increased equity by
a. P419,050 c. P371,050 Royalty revenue (exempt from taxation) P 8,000
b. P411,300 d. P 0 Gain on sale of building 5,000
Entertainment expense (non deductible) 1,700
5. The conversion of the 1,500 6-year, P1,000 face value Depreciation expense - buildings 7,600
bonds on July 1, 2020 increased share premium by Depreciation expense - plant 22,500
a. P1,485,000 c. P1,415,054 Doubtful debts expense 4,100
b. P1,374,608 d. P1,377,697 Annual leave expense 46,000
Insurance expense 4,200
PROBLEM NO. 5 Development expense 15,000
Jackie Corporation has entered into an agreement to lease
a machine to a Lessee Corporation. The lease agreement The company's draft balance sheet at 30 June 2020
details are as follows: showed the following assets and liabilities:
Length of lease 5 years Assets
Commencement date 1 January 2020 Cash P 2,500
Annual lease payment payable 31 Accounts receivable 21,500
December each year commencing Allowance for doubtful debts (4,100) P 17,400

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 Inventory 31,600 3. Deferred tax liability
Prepaid insurance 4,500 a. P9,450 c. P48,125
Land 75,000 b. P7,875 d. P 1,575
Buildings 170,000
4. Deferred tax asset
Accumulated depreciation (59,500) 110,500
a. P14,560 c. P10,185
b. P11,760 d. P 9,310
Plant 150,000
Accumulated depreciation (67,500) 82,500 5. Deferred tax expense (benefit)
Deferred tax asset, (opening a. (P22,780) c. P20,270
balance) 9,600 b. (P19,980) d. (P18,405)
333,600
PROBLEM NO. 7
Liabilities
Accounts payable 25,000 You gathered the following information related to Hanep
Provision for annual leave 10,000 Company’s the defined benefit plan for the year ended
Deferred tax liability (opening December 31, 2020:
balance) 27,270  Fair value of plan assets: P2,100 million at January 1,
Loan 140,000 and P2,340 million at December 31
202,270  Present value of obligation to provide benefits: P2,200
million at January 1, and P2,600 million at December
Additional information 31
a. Quarterly income tax installments paid during the year  Current service cost of providing benefits for the year:
were: P30 million
 Past service cost: P115 million. All of these benefits
28 October 2019 P18,000 have vested.
28 January 2020 17,500  Discount rates and expected rates of return on plan assets:
28 April 2020 18,000
1/1/20 1/1/21
with the final balance due on 28 July 2020. Discount rate 5% 6%
Expected rate of return
b. The tax depreciation rate for plant (which cost
on plan assets 7% 8%
P150,000 three years ago) is 20%. Depreciation on
 Average remaining working life of employees: 10 years
buildings is not deductible for taxation purposes.
 Contributions paid to the fund: P20 million
c. The building sold during the year had cost P100,000  Benefits paid to retired employees: P30 million
when acquired six years ago. The company
depreciates buildings at 5% p.a., straight-line. QUESTIONS:
d. During the year, the following cash amounts were 1. The amount to be recognized in the statement of
paid: financial position as of January 1, 2020 is
Annual leave P52,000 a. P100M surplus c. P400M deficit
Insurance 3,700 b. P100M deficit d. P400M surplus

e. Bad debts of P3,500 were written off against the 2. The amount to be recognized in the statement of
allowance for doubtful debts during the year. financial position as of December 31, 2020 is
a. P260M surplus c. P400M deficit
f. The P15,000 spent (and expensed) on development b. P260M deficit d. P400M surplus
during the year is not deductible for tax purposes until
30 June 2021. 3. The net amount to be recognized in 2020 profit or loss.
a. P 35M c. P150M
g. Roy Ltd has tax losses amounting to P12,500 carried b. P145M d. P180M
forward from prior years.
4. The actual return on plan asset is
h. The company tax rate is 35%. a. P 40M c. P145M
b. P105M d. P250M
REQUIRED:
5. The net amount to be recognized in 2020 OCI is
Compute for the following as of and for the fiscal period a. P30M c. P145M
ended 30 June 2020: b. P35M d. P180M
1. Current tax expense
a. P89,460 c. P77,210
b. P81,585 d. P85,085
2. Current tax payable
a. P31,585 c. P28,025
b. P23,710 d. P35,960

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 DO-IT-YOURSELF (DIY) DRILL

PROBLEM NO. 1 PROBLEM NO. 2

Nuggets’ Music Emporium carries a wide variety of
music promotion techniques - warranties and premiums –
to attract customers.
Musical instrument and sound equipment are sold in a one-
year warranty for replacement of parts and labor. The
estimated warranty cost, based on past experience, is 2%
of sales.
The premium is offered on the recorded and sheet music.
Customers receive a coupon for each peso spent on
recorded music or sheet music. Customers may exchange
200 coupons and P20 for an AM/FM radio. Nuggets pays
P34 for each radio and estimates that 60% of the coupons
given to customers will be redeemed.
Nuggets’ total sales for 2020 were P7,200,000 -
P5,400,000 from musical instrument and sound
reproduction equipment and P1,800,000 from recorded
music and sheet music. Replacement parts and labor for
warranty work totaled P164,000 during 2020. A total of
6,500 AM/FM radio used in the premium program were
purchased during the year and there were 1,200,000
coupons redeemed in 2020.
The following information relates to the obligations of
Lakers Corporation as of December 31, 2020.
a. Accounts payable for goods and services purchased on
open account amounted to P35,000 at December 31,
2020.
b. On December 15, 2020, Lakers declared a cash
dividend of P.05 per share, payable on January 12,
2021, to shareholders of record as of December 31,
2020. Lakers had 1 million ordinary shares issued and
outstanding.
c. On December 31, 2020, Lakers entered into a six-year
finance lease on a warehouse and made the first
annual lease payment of P100,000. The incremental
borrowing rate was 12%, and the interest rate implicit
in the lease, which was known to Lakers, was 10%.
The rounded present value factors for an annuity due
for six years are 4.6 at 12% and 4.8 at 10%.
d. On July 1, 2020, Lakers issued P500,000, 8% bonds
for P440,000 to yield 10%. The bonds pay interest
annually every June 30. At December 31, 2020, the
bonds were trading on the open market at 86 to yield
12%. Lakers uses the effective interest method.

The accrual method is used by Nuggets to account for the e. Lakers’ 2020 accounting profit was P850,000 and its
warranty and premium costs for financial reporting taxable profit was P600,000. The difference is due to
purposes. The balance in the accounts related to P100,000 permanent differences and P150,000 of
warranties and premiums on January 1, 2020, were as temporary differences related to noncurrent assets. At
shown below: December 31, 2020, Lakers had cumulative taxable
differences of P300,000 related to noncurrent assets.
Inventory of Premium AM/FM radio P 39,950 Lakers’ effective tax rate is 30%. Lakers made no
Estimated Premium Claims Outstanding 44,800 estimated tax payments during the year.
Estimated Liability from Warranties 136,000
QUESTIONS:
QUESTIONS:
Based on the above and the result of your audit, determine
Based on the above and the result of your audit, determine the following as of and for the year ended Dec. 31, 2020:
the amounts that will be shown on the 2020 financial
statements for the following: 6. Carrying amount of finance lease liability
a. P480,000 c. P380,000
1. Warranty expense b. P428,000 d. P360,000
a. P108,000 c. P164,000
b. P144,000 d. P80,000 7. Carrying amount of bonds payable
a. P446,400 c. P442,000
2. Estimated liability from warranties b. P444,000 d. P430,000
a. P108,000 c. P136,000
b. P164,000 d. P80,000 8. Current liabilities
a. P342,200 c. P367,000
3. Premium expense b. P327,000 d. P347,000
a. P 75,600 c. P108,000
b. P183,600 d. P126,000 9. Noncurrent liabilities
a. P850,000 c. P895,000
4. Inventory of AM/FM radio b. P854,400 d. P902,800
a. P46,950 c. P77,350
b. P39,950 d. P56,950 10. Interest expense
a. P92,000 c. P44,000
5. Estimated liability for premiums b. P70,000 d. P22,000
a. P75,600 c. P63,450
b. P36,400 d. P44,800  - end of AP.2907 - 

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