Auditing Problems AACONAPPS2

ND
Audit of Liabilities 2 Semester SY 2022-2023
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Auditing Problems
AUDIT OF LIABILITIES
Activity

Problem 1: Current vs. Non-current Liabilities

The following is an excerpt from Cavite Corporation’s trial balance in relation to your audit of its financial
statements as of and for the period ended December 31, 2021:

Cash in bank, net of a P26,000 bank overdraft (no right of offset) 654,000
Accounts receivable, net of a P44,000 credit bal. in a customers’ account (no 217,000
right of offset)
Accounts payable, net of a P37,500 debit bal. in a suppliers’ account (no right 873,500
of offset)
Accrued operating expenses 110,000
Salaries payable – basic pay 236,600
SSS, Philhealth and PAG-IBIG payable 53,100
Withholding tax payable 36,600
Salaries payable - accrued compensated absences and bonuses 67,800
Provisions/estimated liability for warranties 101,600
Provisions/estimated liability from environmental damages, expected to be 56,000
settled in 2022
Provisions/estimated liability from pending litigation cases, expected to be 120,000
settled in 2023 (at present value and adjusted for risk adjustment premium)

Current income tax payable 104,500

Output VAT, net of P25,500 Input VAT 43,500
Deferred tax liability, net of a P59,000 deferred tax asset (no right of offset) 33,500

Cash dividends payable 50,000

Share dividends payable 70,000
12% Serial bonds payable, due P50,000 semi-annually every March 1 and 500,000
September 1. Interests are also payable semi-annually. Final serial payment
due on September 1, 2026.
Accrued interest on serial bonds payable ?
Cash advances from shareholders with an indefinite term 120,000
Financial liability at amortized cost (Notes payable – bank) due 3/31/2022 200,000
(See Note below)
Financial liability at fair market value 150,000

Audit note: On December 31, 2021, the company entered into an agreement with the bank to refinance the
liability by extending the maturity of the note for another year, that is up to March 31, 2023.

Requirements: Determine the following:

1. Total current liabilities
2. Total non-current liabilities

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Auditing Problems AACONAPPS2
ND
Audit of Liabilities 2 Semester SY 2022-2023
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Problem 2: SL-GL Reconciliation / Search for Unrecorded Liabilities

You are auditing Negros Occidental Corporation’s current liability accounts as of December 31, 2021. The
following schedule of liabilities was presented to you by the company’s accountant in relation to your audit:

Accounts payable P3,360,000

Accrued operating expense 62,000

Audit note:
a. General Ledger – Subsidiary Ledger Reconciliation
The accountant of Negros Occidental Corporation provided you the following reconciliation of accounts
payable control account and subsidiary ledger account in connection with your audit of its accounts
payable:

Balance per control account (General ledger) 3,360,000

Purchase Invoice for goods received on January 5, 2022 350,000
Purchase invoice on goods still in transit as of December 31, 2021.
Term FOB supplier’s warehouse. 300,000
Cost of goods received on December 29, 2021. Purchase invoice
documents received only on January, 2022 (150,000)
Payments to supplier in which the check is dated January 2, 2022
and were released on December 30, 2021 (220,000)
Payments to supplier in which check is dated December 30, 2021
and were released on January 2, 2022 340,000
Payments to supplier in which check is dated December 30, 2021
and were released on the same date. (200,000)
Purchase returns (30,000)
Debit balance on a suppliers’ account 80,000
Balance per subsidiary ledgers 3,830,000

b. Cash Disbursements Cut-Off (Search for Unrecorded Liabilities)

The following is a summary of entries before and after the balance sheet date on the cash disbursement
journal of Negros Occidental Corporation:

Voucher Account Charged

Entry date Reference Description Amount (Debited)
Dec. 18, 2021 12 - 200 Lawyers’ retainers fee for Dec. 35,000 Professional fees
Fire insurance, 12/1/2021 to
Dec. 26, 2021 12 - 203 11/30/2022 48,000 Prepaid insurance
Repairs and
Fee for building maintenance for the maintenance
Dec. 28, 2021 12 – 215 month of December 24,000 expense
Jan. 3, 2022 1–1 CPA’s retainer’s fee for Dec. 46,000 Professional fees
Accrued Operating
Jan. 4, 2022 12 – 214 December electricity bill 62,000 Expense
Medical services for employees in
Jan. 5, 2022 1–2 2021 52,000 Medical expense
Payroll 12/22/2021 to 1/6/2022 (12 Salaries and
Jan. 6, 2022 1–3 work days, 5 days in Jan.) 84,000 wages
Jan. 12, 2022 1–4 Royalties in December 39,000 Royalty expense

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Auditing Problems AACONAPPS2
ND
Audit of Liabilities 2 Semester SY 2022-2023
_______________________________________________________________________________________________________

Repairs and
Repairs services on factory equipment maintenance
Jan. 14, 2022 1–5 in January 19,000 expense

Required:
1. What is the adjusted balance of the accounts payable account?
2. What is the correct accrued expenses as of December 31?

Problem 3: Estimated Liabilities – Warranty and Premium

Dolores’ 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. Dolores pays P34 for each radio and estimates that 60% of the coupons given to customers will be
redeemed.

Dolores total sales for 2021 were P57,600,000 – P43,200,000 from musical instrument and sound
reproduction equipment and P14,400,000 from recorded music and sheet music. Replacement parts and
labor for warranty work totaled P1,312,000 during 2021. A total of 52,000 AM/FM radio used in the
premium program were purchased during the year and there were 9,600,000 coupons redeemed in 2021.

The accrual method is used by Dolores to account for the warranty and premium costs for financial
reporting purposes. The balance in the accounts related to warranties and premiums on January 1, 2021,
were as shown below:

Inventory of Premium AM/FM Radio P 319,600

Estimated Premium Claims Outstanding 358,400
Estimated Liability from Warranties 1,088,000

Required:
1. Warranty expense
2. Estimated liability from warranties
3. Premium expense
4. Estimated liability for premiums
5. Inventory of AM/FM radios

Problem 4: Provisions and Contingent Liabilities

The following information relates to Alamano Company as of December 31, 2021. Answer the following
questions relating to each of the independent situations as requested.

a. During 2021, Alamano Company guaranteed a supplier’s P500,000 loan from a bank. On October
1, 2021, Alamano was notified that the supplier had defaulted on the loan and filed for bankcruptcy
protection. Counsel believes Alamano will probably have to pay between P250,000 and P450,000

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Auditing Problems AACONAPPS2
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Audit of Liabilities 2 Semester SY 2022-2023
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under its guarantee. As a result of the supplier’s bankruptcy, Alamano entered into a contract in
December 2021 to retool its machines so that Alamano could accept parts from other suppliers.
Retooling costs are estimated to be P300,000. What amount should Alamano as a liability in its
December 31, 2021, statement of financial position?

b. A court case decided on December 21, 2021 awarded damages against Alamano. The judge has
announced that the amount of damages will be set at a future date, expected to be in March 2022.
Alamano has received advice from its lawyers that the amount of the damages could be anything
between P20,000 and P7,000,000. As of December 31, 2021, how much should be recognized in
the statement of financial position regarding this court case?

c. Alamano directors decided on November 3, 2021 to restructure the company’s operation as

follows:
 Factory T would be closed down and put on the market for sale.
 100 employees working in Factory T would be retrenched effective November 30, 2021 and
would be paid their accumulated entitlements plus three months’ wages.
 The remaining 20 employees working in Factory T would be transferred to Factory X, which
would continue operating.
 Five head-office staff would be retrenched effective December 31, 2021 and would be paid their
accumulated entitlements plus three months’ wages.
As at December 31, 2021, the following transactions and events had occurred:
 Factory T was shut down on November 30, 2021. An offer of P80,000,000 had been received
for Factory T. However, there was no binding sales agreement.
 The 100 employees had been retrenched, had left and their accumulated entitlements had been
paid, however an amount of P1,520,000 representing a portion of the three months’ wages for
the retrenched employees, had still not been paid.
 Costs of P460,000 were expected to be incurred in transferring the 20 employees to their new
work in Factory X. The transfer will occur on January 15, 2022.
 Four of the five head-office staff had been retrenched, had left, and their accumulated
entitlements, including the three months’ wages, had been paid. However, one employee, D.
Terminator, remained on to complete administrative tasks relating to the closure of Factory T
and the transfer of staff to Factory X. D Terminator was expected to stay until January 31, 2022,
D Terminator’s salary for January would be P80,000 and his retrenchment package would be
P260,000, all of which would be paid on the day he left. He estimated that he would spend 60%
of his tie administering the closure of Factory T, 30% of his time administering the transfer of
staff to Factory X and the remaining 10% on general administration.
Calculate the amount of the restructuring provision to be recognized in Alamano’s financial
statements as at December 31, 2021.

Problem 5: Financial Liability at Amortized Cost

Nueva Ecija Corporation had the following financial liabilities originated in 2021:
a. On January 2, the company issued a 3-year, P5M non-interest-bearing note in lieu of a land. The fair
value of the land on this date was at P3,756,574. The effective interest under these terms was at
10%.
b. On March 31, the company issued a 1-year 12%, P2.5M notes payable to a supplier of merchandise
inventory. The inventory purchased had a cash selling price of P2.5M.
c. On June 30, the company purchased an equipment with a fair market value of P2,486,852 in lieu of
a P3M non-interest-bearing note. The note is payable at a rate of P1M annually starting June 30,
2022. The effective interest rate on the transaction was at 10%.

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Auditing Problems AACONAPPS2
ND
Audit of Liabilities 2 Semester SY 2022-2023
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Requirements:
1. How much is the interest expense for 2021 and 2022?
2. What is the carrying value of each financial liability and how should each be presented in the 2021
statement of financial position (current vs noncurrent)?

Problem 6: Convertible Bonds

On January 2, 2020, the Mauban Inc. issued P2,000,000 of 8% convertible bonds at par. The bonds will
mature on January 1, 2024 and interest is payable annually every January 1. The bond contract entitles
the bondholders to receive 6, P100 par value, ordinary shares in exchange for each P1,000 bond. On the
date of issue, the prevailing market interest rate for similar debt without the conversion option is 10%.

On January 1, 2024 the holders of the bonds with total face value of P1,000,000 exercised their conversion
privilege. On that date, the bonds were selling P110 and the ordinary share at P42.

Requirements:
1. The proceeds from issuance of convertible bonds to be allocated to the liability component
2. The proceeds from issuance of convertible bonds to be allocated to the equity component
3. The carrying amount of the bonds payable on December 31, 2020
4. The interest expense for the year 2021
5. The gain to be recognized on conversion of the bonds

Problem 7: Debt Restructuring

On December 31, 2021, Dolores Company was indebted to Estrada Co. on a P2,000,000, 10% note. Only
interest had been paid to date. Due to its financial difficulties Dolores Company has negotiated a
restructuring of its note payable. The parties agreed that Dolores would settle the debt on the following
terms:
 Settle one-half of the note by transferring land with a recorded value of P800,000 and a fair
value of P900,000.
 Settle one-fourth of the note by transferring 200,000 shares of P1 par ordinary shares with a
fair value of P1.80 per share.
 Modify the terms of the remaining one-fourth of the note by reducing the interest rate to 5%,
extend the due date three years from the date of restructuring and reducing the principal to
P300,000.

Requirements:
1. Gain on extinguishment of debt on the P1 million note to be recognized in profit or loss
2. Gain on the settlement of P500,000 note by issuing ordinary shares to be recognized in profit or
loss
3. Total gains on extinguishment of debt to be recognized in profit or loss
4. Interest expense in 2022
5. Carrying amount of the note payable as of December 31, 2022.

Problem 8: Leases

On December 31, 2020 Anvaya Corp. leased a machine with an economic life of eight years from Bangka
Corp. with the following terms:

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ND
Audit of Liabilities 2 Semester SY 2022-2023
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 Lease term, five years. Anvaya has an option to extend for additional three years that it does
not intend to exercise.
 Equal annual payments, P525,000 (including P25,000 reimbursement to lessor for annual
executory costs) due on December 31 of each year.
 The first payment was made on December 31, 2020 and the second payment was made on
December 31, 2021.
 Anvaya’s incremental borrowing rate, 10%.
 Residual value at the end of the lease term guaranteed by a third party, P200,000.
 Initial direct costs paid by Sariaya, P120,000.
 Sariaya depreciates its owned assets using straight-line method.

Requirements: (round off present value factors to four decimal places)

1. Right of use asset
2. Lease liability
3. Annual depreciation of the right-of use asset
4. Interest expense for 2021
5. Current portion of the lease liability at December 31, 2021

Problem 9: Pension

The following information relates to the defined benefit pension plan of the Tiaong Company as of January
1, 2020:

Defined benefit obligations (DBO) P16,150,000

Fair value of plan assets 15,135,000

Pension data for the years 2020 and 2021 follows:

2020 2021
Current service cost 870,000 1,150,000
Contributions to the plan 1,200,000 1,250,000
Benefits paid to retirees 1,320,000 1,400,000
Actual return on plan assets 1,463,500 1,720,000
Actuarial change increasing DBO 800,000 -
Settlement interest rate 11% 11%
Long-term expected rate of return on plan assets 10% 10%

The average working life of employees as of January 1, 2021 is 10 years.

Requirements:
1. What is the 2020 net pension expense?
2. The defined benefit obligation as of December 31, 2020
3. The defined benefit liability (asset) at December 31, 2020
4. What is the 2021 net pension expense?
5. The defined benefit liability (asset) at December 31, 2020

Problem 10: Income Taxes

The following differences enter into the reconciliation of accounting profit and taxable profit of Mulanay
Company for the year ended December 31, 2021, its first year of operations.

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Auditing Problems AACONAPPS2
ND
Audit of Liabilities 2 Semester SY 2022-2023
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Life insurance expense P 100,000

Excess tax depreciation 2,000,000
Warranty expense 200,000
Litigation accrual 500,000
Unamortized computer software 3,000,000
Unearned rent income deferred on the books
but appropriately recognized in taxable profit 400,000
Interest income from long-term certificate of deposit 200,000

Additional information:
a. On July 1, 2021 Mulanay paid insurance premium of P200,000 on the life of an officer with Mulanay
Company as beneficiary.
b. Excess tax depreciation will reverse equally over a four-year period, 2022-2025.
c. The warranty liability is the estimated warranty cost that was recognized as expense in 2021 but
deductible for tax purposes when actually paid.
d. It is estimated that the litigation liability will be paid in 2025.
e. In January 2021, Mulanay Company incurred P4,000,000 of computer software cost. Considering
the technical feasibility of the project, this cost was capitalized and amortized over 4 years for
accounting purposes. However, the total amount was expensed in 2021 for tax purposes.
f. Rent income will be recognized during the last year of the lease, 2025.
g. Interest income from the from long-term certificate of deposit (LTCD) is expected to be P200,000
each year until their maturity at the end of 2025. Interest income from LTCD is tax exempt.
h. Accounting profit for 2021 is P10,000,000. Tax rate is 35%.

Required:
1. Deferred tax liability
2. Deferred tax asset
3. Current tax expense
4. Total tax expense

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