7 AUDIT OF LIABILITIES

AUDIT PROGRAM FOR ACCOUNTS PAYABLE

Audit Objectives
To determine that:
a. Accounts payable represents amounts currently payable to trade creditors for purchases of
goods and services as at the balance sheet date.
b. Accounts payable have been properly recorded.
c. Accounts payable are properly described and classified and adequate disclosures have been
made.

Audit Procedures
1. Obtain a list of accounts payable from the subsidiary ledger and:
a. Check its footing.
b. Check if the list reconciles with the general ledger control account.
c. Trace individual balances to the subsidiary ledger.
d. Test accuracy of balances in the subsidiary ledger.
e. Adjust non-trade accounts erroneously included in the suppliers' accounts.
f. Investigate and reclassify significant debit balances.

2. Confirm accuracy of individual balances appearing in the subsidiary ledger by requesting

statements of accounts from suppliers, and:
a. Reconcile suppliers' statements of accounts with the client records and investigate
discrepancy.
b. If suppliers do not respond with the requests, perform extended procedures, like:
b1. Reviewing payments after year end.
b2. Checking supporting documents.
b3. Discussing the account with appropriate officer.

3. Review correspondence with suppliers for possible adjustments.

4. Test propriety of cutoff:

a. Examine purchases recorded and suppliers' deliveries made a week before and after the
balance sheet date and ascertain whether the purchases were recorded in the proper
period.
b. Investigate large amounts of purchases returned shortly after the balance sheet date.

5. Ascertain whether some payables are secured with asset pledges.

6. Compare payments after the balance sheet date with year-end schedule of accounts payable.

7. Review propriety of financial statement presentation and adequacy of disclosures.

.8. Perform analytical review procedures.

9. Obtain accounts payable representation letter.
 AUDIT PROGRAM FOR NON-CURRENT LIABILITIES
Audit Objectives
To determine that:
a. Authorization of liabilities incurred.
b. Validity of recorded liabilities.
c. Recognition and recording of significant liabilities.
d. Compliance with terms, restrictions, conditions, and other requirements of debt agreements.
e. Assets pledged or mortgaged and other guarantees related to long-term liabilities are identified.
f. Accuracy of interest and other charges related to long-term liabilities.
g. Propriety of financial statement presentation and adequacy of disclosures.

Audit Procedures
1. Obtain or prepare schedule/s of long-term liabilities, indicating:
As to general nature:
a. Description or nature of the long-term liabilities.
b. Creditor/s
c. Original principal amount
d. Interest rate
e. Collateral and/or guarantees
f. Terms, restrictions, conditions, and requirements imposed by the creditors.

As to principal amount outstanding:

g. Beginning of the year balance
h. Additions during the year
i. Repayments or renewals during the year
j. Balance at year-end.

As to interest:
k. Accrued or prepaid at the beginning of the year
l. Amount incurred during the year
m. Payments during the year
n. Accrued or prepaid at year-end.

2. Foot and cross-foot the schedule.

3. Verify the accuracy of the schedule.

As to general nature:
a. Obtain copies or excerpts of debt instruments and trace data to the schedule.

As to principal amount outstanding:

b. Trace beginning balances to last year's working papers, or in an initial audit, establish
accuracy of beginning balances by:
b1. Reference to debt instruments and prior year's recordings.
b2. Trace to beginning ledger balances.
c. Trace proceeds to cash receipts records for the new liabilities incurred in the current year.
d. Trace payments to cash disbursements records, and cancelled checks.
e. Vouch to supporting documents the renewals in the current year.
f. Agree working paper ending balances with the general ledger accounts.
 As to interest:
g. Trace beginning balances to last years' working papers, or in an initial audit:
g1. Establish accuracy by an independent computation based on debt instruments.
g2. Trace to beginning ledger balances.
h. Recompute the interest:
h1. Incurred
h2. Accrued
h3. Prepaid.
i. Trace payments to cash records and cancelled checks.

4. Verify authorizations by reference to minutes of the board of directors' meetings.

5. Confirm directly with the creditors or trustees the following:

a. Principal amount still outstanding
b. Interest rates
c. Interest accrued.
d. Collateral and/or guarantees

6. Determine client's compliance with loan agreements.

7. Account for the used and unused debt instruments like bond certificates and promissory notes.

8. Ascertain proper cancelation of paid or retired debt instruments.

9. Recompute the accuracy of any discount or premium amortization.

10. Reconcile interest payments with recorded liabilities.

11. Verify propriety of financial statement presentation and adequacy of disclosures.

 7 problems
Problem 7-1
Recording Purchases
Samuel Company records its purchases t gross amounts but wishes to change to recording
purchases net of purchase discounts. Discounts on purchases recorded from January 1,2019 to
December31, 2019, totaled $80,000. Of this amount, $8,000 is still available in the accounts payable
balance. The balances in Samuel Company's accounts as of and for the year ended December 31,
2019 before conversion are:

Purchases $ 4,000,000
Purchase discounts 32,000
Accounts payable 1,200,000

Required:
1. How much is the amount of purchase discount lost to be recognized?
2. The accounts payable balance should by reduced by how much?
3. The purchases account should be reduced by how much?
4. What is the journal entry to record the conversion?

Problem 7-2
NonInterest-Bearing Note

On December 31, 2019, Columbia Company acquired a machine from Georgia Company by issuing
a $4,000,000 noninterest-bearing note, payable in full on December 31, 2023. Columbia Company's
credit rating permits it to borrow funds from its several lines of credit at 12%. The machine is
expected to have a 10-year life and a $500,000 salvage value. The present value factor of an annuity
of 1 for 4 periods at 12% is 3.03735. The present value of 1 for 4 periods at 12% is 0.63552.

Required:
1. What is the journal entry to record the purchase on December 31, 2019?
2. What is the entry to record the discount amortization at December 31, 2021?

Problem 7-3
Premiums

Andreas Company sold 700,000 boxes of cake mix under a new sales promotional program. Each
box contains one coupon, which if submitted with $40, entitles the customer to a kitchen knife.
Andreas Company pays $60 per knife and $5 for handling and shipping. Andreas Company estimates
that 70% of the coupons will be redeemed, even though only 250,000 coupons had been processed
during 2019.

Required:
Determine the amount of liability for unredeemed coupons at December 31, 2019.

Problem 7-4
Short-term Refinanciing

The following items are based on the financial statements of Malcolm Company:

Current assets $ 750,000

Short-term loan payable 600,000
Total liabilities 3,000,000
Current ratio 1.5
Debt-to-equity ratio 1.5

Malcolm Company has arranged with its bank to refinance its short-term loan when it becomes due in
3 months. The new loan will have a term of 5 years.

Required:
1. Compute the following:
a. Total current liabilities
b. Total shareholders' Equity
c. Total non-current liabilities

2. As the auditor of Malcolm Company, how would you verify the validity of the short-term loan
refinancing?

Problem 7-5
Debt Restructuring: Asset Swap

Colorado Company owes $1,998,000 to London Company. The debts is a 10-year, 11% note.
Because Colorado company is financial trouble, London Company agrees to accept land and cancel
the entire debt. The land has a book value of $800,000 and a fair market value of $1,200,000.

Required:
What entry should be made by Colorado company for debt restructure?

Problem 7-6
Convertible Bonds

Angeles Corporation issued $2,000,000 of convertible 10-year, 11% bonds on July 1, 2019. The interest
is payable semiannually on January 1 and July 1. The discount in connection with the issues was
$19,000, which is amortized monthly using the straight line basis. The debentures are convertible after
1 year into 10 shares of the company's $10 par ordinary shares for each $1,000 bonds.

On August 1, 2020, $200,000 of the bonds were converted. Any interest accrued at the time of
conversion of the bonds is paid in cash.

Required:
What is the journal entry to record the conversion of bonds on August 1?

Problem 7-7
Sale Between Interest Dates, Conversion, and Retirement of Bonds

On April 1, 2009, Finland Company issued $4,000,000 of 7% convertible bonds with interest payment
dates of April 1 and October 1. The bonds were sold on July 1, 2009, and mature on April 1, 2029.
The bond discount totaled $213,300. The bond contract entitles the bond holders to receive 10 shares
of $20 par value ordinary shares in exchange for each $1,000 bond. On April 1, 2019, the holders of
bonds with total face value of $500,000 exercise their conversion privilege. On July 1, 2019, Finland
Company reacquired bonds, face value $250,000.

The balances in the capital accounts as of December 31, 2018 were:

Ordinary shares, $20 par, authorized 2,000,000 shares

issued and outstanding, 125,000 shares
Share premium

Market value of ordinary shares and bonds were as follows:

Date Bonds Ordinary Shares

April 1, 2019 122 52

July 1, 2019 125 56

Required:
Prepare journal entries on the issuer's books for each of the following transactions. (Use the
straight-line amortization method for the bond discount)

1, Sale of the bonds on July 1, 2009.

2. Interest payment on October 1, 2009.
3. Interest accrual on December 31, 2009.
4. Bond discount amortization on December 31, 2009.
5. conversion of bonds on April 1, 2019.
6. Reacquisition and retirement of bonds on July , 2019 at 125 plus accrued interest.

Problem 7-8
Liability Under Finance Lease
Jamaica Company enters into a lease agreement with Lebanon Corporation on July 1,2019 to lease
a machine to be used in its manufacturing operations.

The following data pertain to this agreement:

1. The term of the noncancellable lease is 3 years, with no renewal option and no residual value
at the end of the lease term. Payments of $212, 024 are due on July 1 of each year, beginning
July 1, 2019.

2. The fair value of the machine on July 1, 2019 is $620,000. The machine has a remaining life of
5 years, with no salvage value. The machine reverts to the lessor upon the termination of the
lease.

3. Jamaica company elects to depreciate the machine on the straight-line method.

4. The interest rate implicit in the lease is 10%.

6. The present value factor of an ordinary annuity of 1 for 3 periods at 10% per year is 2.48685. The
present value factor of an annuity due of 1 for 3 periods at 10% is 2.73554.

Required:
Determine the amount of lease liability to be recognized by Jamaica Company at the beginning
of the lease contract.

Problem 7-9
Warranties

Barbados Company, a machinery dealer, sells a machine for $22,000 under a 1-year warranty contract
that requires the company to replace all defective parts and to provide the necessary repair labor at
no cost to the customers. With sales being made evenly throughout the year, Barbados company
sells for cash 600 machines in 2019 (half of the warranty expense is incurred in 2019, half in 2020). On
the basis of past experience, the 1-year warranty costs are estimated to be $510 parts and $660
labor.

Required:
Assume that in 2019, these warranty costs are incurred exactly as estimated:
a. What amount of warranty expense would be charged against 2019 revenue?
b. What amount of warranty liability would appear on the December 31, 2019 statement of
financial position?

Problem 7-10
Analyzing Various Transactions Involving Liabilities

In conjunction with your firm's examination of the financial statements of Batam Company as of
December 41, 2019, you obtained the information from the company's voucher register shown in
the working paper below:

Item Voucher
No. Entry Date Reference Description Amount

1. 12/18/19 12-200 Supplies, shipped FOB Destination

12/15/19; received 12/17/19 $ 15,000

2. 12/18/19 12-203 Auto insurance, 12/15/19 -12/15/20 22,000

3. 12/21/19 12-209 Repairs services; received 19,000

12/20/19

4. 12/26/19 12-212 Merchandise, shipped FOB

shipping point, 12/20/19;
received 12/24/19 123,000

5. 12/21/19 12-210 Payroll, 12/7/19 - 12/21/19

(12 working days) 69,000

6. 12/21/19 12-234 Subscription to industry

magazine for 2020 5,000

7. 12/28/19 12-236 Utilities for December 2019 24,000

8. 12/28/19 12-241 Merchandise, shipped FOB

destination, 12/24/19; received
1/2/20 111,500

9. 12/28/19 12-242 Merchandise, shipped FOB

destination, 12/24/19; received
1/2/20 84,000

10. 1/2/20 1-1 Legal service, received 12/28/20 46,000

11. 1/2/20 1-2 Medical services for employees

for December 2019 25,000

12. 1/5/20 1-3 Merchandise, shipped FOB

shipping point, 12/29/19; received
1/4/20 55,000

13. 1/10/20 1-4 Payroll, 12/21/19 - 1/5/20 (12

 working days in total,4 working
days in January 2020) 72,000

14. 1/10/20 1-6 Merchandise, shipped FOB

shipping point, 1/2/20; received
1/6/20 64,000

15. 1/12/20 1-8 Merchandise, shipped FOB

destination, 1/3/20; received
1/10/20 38,000

16 1/13/20 1-9 Maintenance service, received

1/9/20 9,000

17. 1/14/120 1-10 Interest on bank loan,

10/10/19 - 1/10/20 30,000

18. 1/15/20 1-11 Manufacturing equipment,

installed 12/29/19 254,000

19. 1/15'20 1-12 Dividends declared, 12/15/19 160,000

Accrued liabilities as of December 31, 2019 were as follows:

Accrued payroll $ 48,000

Accrued interest payable 26,666
Dividends payable 160,000

The accrued payroll and accrued interest payable were reversed affective January 1, 2020.

Required:
Review the data given above and prepare journal entries to adjust the accounts on December 31,
2019. Assume that the company follows FOB terms for recording inventory purchases.

Problem 7-11
Bond Redemption Prior to Maturity Date

The following data were obtained from the initial audit of Hongkong Company:

15 %, 10-year, Bonds Payable, dated January 1, 2018:

Description Debit Credit

Cash proceeds from issue on January 1, 2018, of

1,000 bonds. The market rate of interest on the
date of issue was 12% $ 1,172,044
Bond interest expense
Cash paid, 1/2/19 $ 75,000
Cash paid, 7/1/19 75,000
Accrual, 12/31/19 75,000

Accrued Interest on Bonds

Balance, 1/1/19 $ 75,000
Accrual, 12/31/19 75,000

Treasury Bonds
Redemption price and interest to date on 200 bonds
permanently retired on December 31, 2019 $ 265,000

Required:
Based on the preceding information, determine the following:
1. Carrying value of bonds payable at December 31, 2019.
2. Gain or loss on bond redemption.
3. Accrued interest on bonds at December 31, 2019.
4. Bond interest expense for the year ended December 31, 2019.
cording Purchases

uary 1,2019 to
e accounts payable
ed December 31,

erest-Bearing Note

mpany by issuing
umbia Company's
machine is
factor of an annuity
s 0.63552.

Premiums

program. Each
tchen knife.
Company estimates
d been processed
t-term Refinanciing

n it becomes due in

the short-term loan

uring: Asset Swap

r, 11% note.
pt land and cancel
$1,200,000.

Convertible Bonds

y 1, 2019. The interest

the issues was
 are convertible after

at the time of

etirement of Bonds

h interest payment
on April 1, 2029.
to receive 10 shares
019, the holders of
y 1, 2019, Finland

$ 2,500,000
1,250,000

actions. (Use the

d interest.

nder Finance Lease

y 1,2019 to lease

residual value
year, beginning

remaining life of
mination of the

ar is 2.48685. The

ny at the beginning

Warranties

ear warranty contract

ary repair labor at
bados company
19, half in 2020). On
arts and $660

19 statement of

nvolving Liabilities

mpany as of
ister shown in

Account
Charge

Supplies on
Hand

Prepaid
Insurance

Repairs and
maintenance

Inventory

Salaries and
wages

Dues and
subscription exp.

Utilities Expense

Inventory

Inventory

Legal and
professional
fees expense

Medical expense

Inventory
 Salaries and
wages

Inventory

Inventory

Repairs and
maintenance

Interest
Expense

Machinery and
Equipment

Dividends
payable

unts on December 31,

purchases.

ior to Maturity Date

:
Balance

$ 1,172,044
$ 75,000
75,000
75,000

$ 75,000
75,000

$ 265,000