ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 42 Ÿ October 2021 CPA Licensure Exam Ÿ Weeks 1 - 4

AUDITING (Auditing Problems) S. Ireneo Ÿ C. Espenilla

AP-100: FINANCING CYCLE: AUDIT OF STOCKHOLDERS’ EQUITY

PROBLEM 1:

1. After understanding a financial statements’ audit client’s financing cycle in relation to his audit of
the client’s stockholders’ equity account, the auditor decided to place preliminary audit risk
(inherent and control risk) at a high level, which of the following is correct?
A. The auditor should next test controls’ effectiveness through further inquiry, inspection,
observation and reperformance.
B. The auditor should go directly to substantive test procedures which may be rendered to interim
period ended balances.
C. The auditor should go directly to substantive test procedures heavily relying on substantive test
analytical procedures.
D. The auditor should go directly to substantive test procedures heavily relying on substantive test
of details.

2. Which of the following statements is true?

A. If control risk is assessed at maximum, the nature of related substantive tests should be changed
from more to less effective.
B. If control risk is assessed at maximum, the nature of related substantive tests should be changed
from less to more effective.
C. If control risk is assessed at maximum, the timing of related substantive tests should be changed
from year-end to an interim date.
D. If control risk is assessed at maximum, the extent of related substantive tests should be changed
from a larger to a smaller sample.

3. Which of the following is incorrect when auditing account balances resulting from non-routinary
transaction cycle such as stockholders’ equity balances arising from financing cycle?
A. The auditor should render risk assessment procedure to understand the client’s internal control
and regardless of the design and operation, should place audit risk at a high level so as to render
directly extensive substantive testing.
B. The auditor should render risk assessment procedure to understand the client’s internal control
after which should test the control’s effectiveness where controls are potentially reliable as to
design and operation.
C. The auditor after rendering risk assessment procedure to understand the client’s internal control
should plan to gather more persuasive evidence using more extensive evidence gathering
procedures.
D. The auditor after rendering risk assessment procedure to understand the client’s internal control
should plan to place the timing of his substantive test procedures at year-end.

4. When auditing stockholders’ equity transactions and related balances, there is higher risk of
_____________, thus the auditor most likely would be focusing on _________ assertions?
A. Understatement error; Completeness and valuation assertions
B. Understatement error; Existence/occurrence and valuation assertions
C. Overstatement error; Completeness and valuation assertions
D. Overstatement error; Existence/occurrence and valuation assertions

5. Significant stockholders’ equity transactions such as share issuance, treasury share transactions,
share rights issuances, dividend declaration, among others, usually undergo authorization of the
no less that the board of directors of a corporation, as a result the auditor usually obtains
evidence regarding authorization of these transactions through:
A. Transfer agent’s records
B. Inter-office memoranda
C. Minutes of meetings of the BOD
D. Stock certificate files

6. In tests concerning the valuation of stock options, an auditor should:

A. Trace the authorization for the transaction to a vote of the board of directors.
B. Refer to market quotations
C. Verify existence of option holders in the entity’s payroll records or stock ledgers.
D. Determine that sufficient treasury stock is available to cover any new stock issued.

7. When the client-company does not maintain its own stock records, the auditor should obtain
written confirmation form the transfer agent and registrar concerning:
A. Restrictions on the payments of dividends.
B. The number of shares issued and outstanding.
C. Guarantees of preference shares liquidation value.
D. The number of shares subject to agreements to repurchase

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8. Which of the following is not included in an audit program for the examination of the retained
earnings account?
A. Verification of the market value used to charge retained earnings to account for 10% stock
dividends.
B. Verification of the approval of the adjustment to the beginning balance as a result of a change
in accounting policy involving inventory costing formula.
C. Verification of the legal appropriation for treasury share balance at year-end.
D. Verification of the gain or loss resulting from disposition of treasury shares.

PROBLEM 2: (SFP PRESENTATION; SHARE ISSUE)

Alpha Corporation had the following equity transactions at the beginning of 2020, its first year of
operations:
A. The company issued 20,000 ordinary shares (P50 stated value) and 8,000 preference shares
(P100 par value) for a lump-sum amount P2.5M. The prevailing fair values of ordinary shares
and preference shares on the date of issuance was at P66 per share and P110 per share,
respectively.

B. Additional 5,000 ordinary shares and 2,000 preference shares were subscribed at P70 per
share and P120 per share, respectively. 20% of the subscriptions price for both ordinary and
preference shares remained outstanding as of December 31, 2020. The receivable balance
from ordinary shares were collectible within the next 12 months, while the receivable balance
from preference shares are non-current.

C. There were no other transactions affecting the company’s issued and subscribed shares during
the year.

D. A partial list of the accounts and ending account balances taken from the post-closing trial
balance of Alpha Corporation on December 31, 2020 is shown below:

Ordinary shares ?
Preference shares ?
Ordinary shares subscribed ?
Preference shares subscribed ?
Share premium – Ordinary shares ?
Share premium – Preference shares ?
Subscriptions receivable – Ordinary shares ?
Subscriptions receivable – Preference shares ?
Bonds payable 220,000
Long-term investment in shares 210,000
Premium on bonds payable 30,000
Share premium from treasury stock transactions 24,000
Additional paid-in capital - bond conversion option 15,000
Accum. unrealized holding gain on financial asset at fair value 113,000
through other comprehensive income/losses
Accum. revaluation surplus/reserves 450,000
Accum. remeasurement loss on accumulated benefits obligation and 95,000
plan assets
Accum. foreign exchange translation reserves, debit 100,000
Accum. hedging reserves, credit 315,000
Ordinary share options outstanding 15,000
Ordinary share warrants outstanding 5,000
Treasury shares, 2,000 ordinary shares at cost 120,000
Accumulated profits – appropriated for treasury shares ?
Accumulated profits – appropriated for plant expansion 100,000
Accumulated profits - unappropriated 450,000
Accumulated profits – debt repayment 100,000
Donated capital 220,000

Required: Determine the adjusted balance of the following as of December 31, 2020:
1. Total additional paid-in capital?

2. Total contributed capital?

3. Total stockholders’ equity?

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PROBLEM 3: (SHARE ISSUE; TREASURY SHARES; CONVERTIBLE PREFERENCE SHARES)

You were assigned to audit the shareholders’ equity of Beta Corp. for the year ended December 31,
2020. Beta Corp. was incorporated in early 2019 when it was authorized by SEC to issue 100,000
ordinary shares (P50 par) and 50,000 preference shares (P100 par). The following schedule reflects
the company’s capital balances as of December 31, 2019:

Ordinary shares, 50,000 shares issued at inception of operations in lieu of a P2,500,000

Land and Building with a total fair market value of P4M (40% attributed to the
Land.)
Preference shares, 20,000 shares issued in June 30, 2019 at P170 per share. 3,400,000
One preference share can be convertible to three ordinary shares
Retained earnings, which is the company’s net income in 2019 2,987,000
Total shareholders’ equity ?

Your inquiries and investigation revealed the following transactions which occurred in 2020:
a. On January 5, the company reacquired 10,000 ordinary shares at P900,000 and held them as
treasury shares.
b. On March 31, the company issued 20,000 additional ordinary shares with P2M, 10% face value
bonds for a lump sum consideration amounting to P3,350,000. The bonds which pay interest
every December 31 and shall mature on December 31, 2025 were currently quoted in the
market at 105 (excluding accrued interest) while each ordinary share is selling currently in the
market at P85.
c. On April 5, the company reissued 2,000 of the treasury shares reacquired on January 5 at
P120 per share.

d. On July 20, the company reissued 3,000 of the treasury shares reacquired on January 5 in lieu
of professional services received from lawyers. The fair value of the services received was at
P245,000 which is believed to be reflective of the prevailing fair value of the shares on that
date.
e. On August 1, the company retired and reverted to unissued basis 2,000 of the treasury shares
reacquired on January 5.
f. On October 31, 5,000 of the preference shares were converted to ordinary shares.

g. The company registered an adjusted net income in 2020 at P2,230,000.

Based on the information above, determine the adjusted balance of the following as of Dec. 31, 2020:
1. Ordinary Shares

2. Preference Shares

3. Share premium – Ordinary shares

4. Share premium – Preference shares

5. Share premium – Treasury shares

6. Additional Paid-in Capital

7. Contributed Capital

8. Stockholders’ Equity

PROBLEM 4: (SHARE ISSUE; PREFERENCE SHARES WITH WARRANTS)

You were assigned to audit the shareholders’ equity of Charlie Inc. for the year ended December 31,
2020. Charlie Corp. was incorporated in early 2019 when it was authorized by SEC to issue 500,000
ordinary shares (P50 par) and 100,000 preference shares (P20 par). The following schedule reflects
the company’s capital balances as of December 31, 2019:
Ordinary shares, 100,000 shares issued during the company’s incorporation in 5,000,000
exchange of a land. The fair value of the land was not clearly determinable on
the date of share issuance while the shares were selling in the market at P55
per share.
Preference shares, 200,000 share issued during the company’s incorporation 6,000,000
at P30 per share.
Retained earnings, which is the company’s net income in 2019 2,980,000
Total shareholders’ equity ?

Your inquiries and investigation revealed the following transactions, which occurred in 2020:

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a. On March 1, the company received subscriptions for 50,000 ordinary shares at P70 per share
from five subscribers (10,000 shares each). The subscribers were required to pay 25% of the
subscriptions price in cash as down payment with balance to be settled after 3 months.
b. June 1, the company received the balance from three share subscribers on March 1. Shares
were therefore issued. The other two defaulted on the balance. As per agreement, the
company auctioned out the defaulted shares and incurred P120,000 in auction expenses.
c. On September 1, the highest bidder on the defaulted shares was selected and the amount due
was collected. The amount due includes a 12% annual interest on the subscriptions’ receivable
balance defaulted.
d. On October 1, the company issued 20,000 preference shares for P840,000. Each preference
share was issued with five warrants. Two warrants can be exercised to purchase one ordinary
shares at P55 per share. The preferences shares were currently selling in the market at P34
per share while each warrant can be sold separately at P1.20 per warrant.
e. On November 12, 60% of the warrants were exercised.
f. On December 5, a debt restructuring agreement was entered with a debtor for an overdue
loans payable outstanding amounting to P800,000 with unpaid interest of P80,000. The debtor
agreed as a concession to accept 10,000 ordinary shares in full settlement of the loan. This
agreement is outside the normal/original credit term. Ordinary shares are currently selling at
this time at P78 per share.
g. The company registered an adjusted net income in 2020 at P1,390,000.

Based on the information above, determine the adjusted balance of the following as of Dec. 31, 2020:
1. Ordinary Shares

2. Preference Share

3. Share premium – Ordinary shares

4. Share premium – Preference shares

5. Ordinary share warrants outstanding

6. Total additional paid-in capital

7. Total contributed capital

8. Total stockholders’ equity

PROBLEM 5: (OPTIONS/EQUITY-SETTLED SHARE BASED PAYMENTS)

On January 1, 2020 Delta Co. issued 200 share options to each of its 100 executive officers. The
options vest at the end of a 4-year period. On the date of the grant, each share option had a fair
value of P24. Delta expects that all the options granted shall become exercisable.
Four options together with P110 per share shall entitle to holder to acquire an ordinary share (P100
par value). Options shall expire by the end of 2024.

Requirements:
1. The salaries expense for 2020 assuming that no change in estimate occurs by the end of the year:

2. The salaries expense in 2021 assuming that 5 employees left 2021 and that an additional 5 more
are expected to leave by the end of the vesting period:

3. The salaries expenses in 2022 assuming that 3 more employees actually left in 2022 and an
additional 3 more will leave by the end of the vesting period:

4. The salaries expense in 2023 assuming that only 1 additional employee left in 2023:

5. The credit to the share premium account as a result of the the exercise of 80% of the options in
2024:

PROBLEM 6: (OPTIONS/EQUITY-SETTLED SHARE BASED PAYMENTS)

On January 1, 2020, Echo Corporation issued 50 share options to 250 employees that will vest once
its share price equals P75. The employee is required to be employed with the company at the time
the condition is met in order to receive the options. Two options together with P60 per share entitles
the holder to acquire 1 ordinary share (P50 par value). The share options will expire in 5 years. On
the date of grant, it is expected that the condition will be satisfied in 3 years (estimated vesting
period)

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The company applies a binomial options pricing model, which takes into account the possibility that the
share price will equal/exceed P75 in 3 years (hence the share options become excercisable) and the
possibility that the share price will not equal/exceed P75 in 3 years (hence the option will be forfeited,
that is reverted back to equity). The company estimates that the market value of the stock option on
the date of grant with this market condition is P30 per option.
The following information are deemed relevant:
Date Estimated total number of Actual Share
employees who will leave the Price at the end
company by the end of 2022 of each year
Dec. 31, 2020 20 60
Dec. 31, 2021 30 68
Dec. 31, 2022 25* 76
*Total actual number of employees who left the company.

Requirements:
1. What is the compensation expense to be recognized in 2020?

2. What is the compensation expense to be recognized in 2021?

3. What is the compensation expense to be recognized in 2022?

4. Assuming that the actual share price amounted to P70 at end of 2022, what is the compensation
expense to be recognized in 2022?

5. Assuming that the actual share price amounted to P75 at the end of 2021, what is the compensation
expense in 2021?

PROBLEM 7: (OPTIONS/EQUITY-SETTLED SHARE BASED PAYMENTS)

On January 1, 2020, Foxtrot Company granted share options to 100 of its key employees entitling them
to acquire P100 par value shares of the company at an exercise rate of one option plus P115 per share
conditional upon the employees’ remaining in the company’s employ during the vesting period. The
10,000 share options (100 options per employee) shall vest at the end of 2020 if the company’s 2020
revenues reach P90M ; or at the end of 2021 if the company’s 2021 revenues reach P100M; or at the
end of 2022 if the 2022 revenues reach P110M.
The market value of the option on the date of grant is P18. The company has a steady pattern of 25%
increase in revenues every year over the last 5 years and expects the same pattern during the vesting
period.
The following information are deemed relevant:
Year Estimated total number of Actual Revenue
employees who will stay by
the end of the vesting period
2020 85 P80M
2021 90 90M
2022 80* 110M
*Total actual number of employees who stayed with the company.

Requirements:
1. What is the salaries expense to be recognized in 2020?
2. What is the salaries expense to be recognized in 2021?
3. What is the salaries expense to be recognized in 2022?
4. If the employees exercised all their options in 2023, what is the effect to the total APIC as a result
of the exercise?

PROBLEM 8: (STOCK APPRECIATION RIGHTS/CASH-SETTLED SHARE BASED PAYMENTS)

On January 1, 2020, Golf Co. issued share appreciation rights (SARs) to its 50 employees. The SARs
will vest at the end of 3 years, provided the employees remain with the company and provided that
revenue in 2022 is at least P100M. The share option entitlement of each employee depending upon
the actual revenue in 2022 is:
2022 Revenue No. of SARs per Employee
P100M – P150M 1,000
>P150M – P200M 1,200
> P200M 1,500

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The company has a steady pattern of 30% increase in revenues every year over the last 5 years and
expects the same pattern during the vesting period.

The following information are deemed relevant:

Estimated total
number of
Year Actual Revenue employees who will Fair market
leave the company by value of SAR
the end of 2022
12/31/2020 P90M 0 P25
12/31/2021 110M 5 P30
12/31/2022 201M 10* P34
*Total actual number of employees who left the company.

Requirements:
1. Salaries expense in 2020:

2. Salaries expense in 2021:

3. Salaries expense in 2022:

4. Entry to record the exercise of 60% of SARs in 2023 assuming that the fair value of SAR on the
exercise date is at P38:

5. Entry to record the remeasurement of the remaining SARS by the end of 2023 assuming that the
fair value of SARs at the end of 2023 is at P32 per SAR?

PROBLEM 9: (SHARE-BASED PAYMENTS WITH CASH ALTERNATIVE)

On January 1, 2020, Hotel Corp. grants its COO the right to choose either 10,000 ordinary shares or
to receive cash payment equal to 7,500 shares. These are to vest after rendition of two years of
service. Par value of the company’s share of stock is P100. The COO exercised his rights on
September 30, 2022. The fair value information follow:
FMV
Compound Instrument: 1/1/20 P120
Share of Stock: 1/1/20 130
12/31/20 136
12/31/21 144
12/31/22 150

Requirements:
1. What is the balance of SAR payable as of December 31, 2020 and 2021?
2. What is the balance of the ordinary share option outstanding as of December 31, 2020 and 2021?
3. What is the total salaries expense related to the share-based payments in 2020 and 2021?
4. Entry to record the exercise assuming the employee opted settlement in cash in September 30,
2022.
5. Entry to record the exercise assuming the employee opted to receive shares in September 30,
2022.

PROBLEM 10: (SHARE SPLIT; CASH DIVIDENDS; SHARE DIVIDENDS)

India Corp. reported the following amounts in the shareholders’ equity section of its December 31,
2019, statement of financial position:
Preference shares, P5 par (100,000 shares authorized, P300,000
60,000 shares issued)
Ordinary shares, P10 par (50,000 shares authorized, 25,000 shares issued) 250,000
Share premium – Ordinary shares 192,000
Share premium – Preference shares 120,000
Share premium – Treasury shares 15,000
Accumulated profits 1,200,000

The following transactions occurred during 2020:

a. On February 13, the company purchased 5,000 shares of its own outstanding ordinary shares
for P120,000.

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b. On March 30, the company declared and issued a 20% stock dividend on outstanding ordinary
shares. The fair market value of ordinary shares on this date was at P12.
c. On April 15, the company received subscription for 10,000 shares of preference shares at P8
per share.
d. On June 31, P5 per share dividend on ordinary and P2 per share dividend on preference shares
were declared. These dividends shall be paid on July 15.

e. On July 30, the company declared and issued ordinary shares split-up (1 is to 2) on ordinary
shares.
f. On August 1, the company reissued 4,000 treasury shares for an equipment with a fair value
at P25,000.
g. On September 30, the company declared and issued a 10% stock dividend on the outstanding
ordinary shares when the stock is selling for P7.50 per share.
h. On October 1, the company collected in full the subscriptions receivable on preference shares.
i. December 1, the company declared P2.50 dividend on ordinary shares and the P2 per share
dividend on preference shares. These dividends are payable at the beginning of 2020.
j. The company registered a net income for 2020 at P940,000.

Requirements:
1. What is the amount debited to retained earnings as a result of the 20% stock dividends in item b?
2. What is the amount debited to retained earnings as a result of the cash dividends in item d?

3. What is the effect to total stockholders’ equity as a result of the share split in item e?
4. What is the amount debited to retained earnings as a result of the 10% stock dividends in item g?

5. What is the amount debited to retained earnings as a result of the cash dividends in item i?

6. What is the balance of the retained earnings-unappopriated as of December 31, 2020?

PROBLEM 11: (SHARE DIVIDENDS AND FRACTIONAL SHARE WARRANTS)

Juliet Co. has 50,000 ordinary shares (P10 par value) issued and 5,000 ordinary shares in the treasury
(P12 cost per share). In declaring and distributing a 30% stock dividend, Juliet Co. initially issued
only 10,000 new shares; the other shares were not issued because some investors did not own Juliet
Co. shares in even multiples of the share dividends declared. To these shareholders, Juliet Co. issued
fractional share warrants. 60% of these fractional warrants were eventually redeemed in full shares by
the shareholders.

Prepare the journal entries for the following:

1. Declaration of share dividend
2. Issuance of full shares and fractional warrants
3. Issuance of full shares through the surrender of 60% fractional share warrants.
4. Expiration of the remaining fractional warrants.

PROBLEM 12: (PROPERTY DIVIDENDS)

On October 31, Kilo Inc. declared a building as property dividend distributable to stockholders on January
31 of the following year. The building had a carrying value of P1.5M on October 31. The building had
a fair market value of P1.4M on the same date. On Dec. 31 the value of the building further deteriorated
and latest estimates placed the fair value of the building at P1.2M. Cost to dispose the property was
consistently estimated at 10% of the estimated selling price/fair value.

The building was transferred to shareholders on January 31 when the prevailing fair value of the building
was at P1.3M.

Required:
1. The entry to record the declaration of the property dividends would include a debit to retained
earnings of:
2. How much loss should be recognized in the income statement on the reclassification of the
building to asset held for disposal on the declaration date?
3. How much property dividends payable should be reported in the statement of financial; position as
of December 31?

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4. What is the gain or loss to be recognized in the profit or losses as a result of the distribution of the
property dividends on January 31?

5. Assuming that the property declared as dividends are financial assets at fair market value through
profit or loss, what is the gain or loss on the settlement date?

6. Assuming that the property declared as dividends are inventories, what is the gain or loss on the
settlement date?

PROBLEM 13: (QUASI-REORGANIZATION)

Lima Inc. has sustained heavy losses over a period of time and conditions warrant that Lima Inc. undergo
a quasi-reorganization on December 31, 2020.

The balance sheet of Lima Inc. on December 31, prior to the reorganization is:

Current assets P1,000,000

Property, plant and equipment P5,000,000
Less: Accumulated depreciation 1,500,000 3,500,000
Goodwill 500,000
Total assets P5,000,000

Current liabilities P1,100,000

Ordinary shares, P100 par value 5,000,000
Share premium on ordinary shares 500,000
Deficit (1,600,000)
Total assets P5,000,000

CASE 1:
The stockholders and creditors approved the quasi-reorganization effective January 2, 2021, to be
accomplished by: (a) a reduction in property, plant, and equipment (net) P3,100,000; (b) goodwill
should be written off; (c) a write-down of inventories (current asset) by P125,000; (d) a recognition of
additional accrued expenses at P75,000; and, (e) reduction in par value from P100 to P50.

Required:
1. Lima Inc.’s total assets after quasi-reorganization:
2. The balance in the Additional paid-in capital after the quasi-reorganization:
3. Total stockholders’ equity after the quasi-reorganization:

CASE 2:
The Securities and Exchange Commission approved the quasi-reorganization on the basis of the
unrealistic valuation of the property, plant and equipment. Accordingly, the SEC recommended that the
PPE be appraised by an independent expert.
a. The PPE are determined to have replacement cost of P9,000,000.
b. The inventory is to be written down by P400,000.
c. The goodwill should be written-off.
d. Unrecorded accounts payable amounted to P200,000.
e. Any resulting deficit is charged against the revaluation surplus.

Required:
1. Lima Inc.’s total assets after the quasi-reorganization:
2. The balance in the Revaluation surplus after the quasi-reorganization is:
3. Total stockholders’ equity after the quasi-reorganization:

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