PrE 3 – Auditing and Assurance Concepts and Application 2

FINAL EXAMINATIONS

You have been engaged to audit MLD Corporation, a new client, for the year ended, December 31,
2020. The company prepared the trial balance set forth below, as of December 31,2020,the close of its second
year of operations.

Account Titles Unadjusted Trial Balance

Debit Credit
Cash 1,689,255.00
Petty Cash Fund 25,000.00
Trading Securities 700,150.00
Accounts Receivable – Trade 1,817,500.00
Allowance for doubtful accounts 103,500.00
Advances to Officers and Employees
Receivable from Cash Custodian
Accounts Receivable – Assigned
Note Receivable 200,000.00
Receivable from Factor
Discount on Notes Receivable
Cash Held as Compensating Balance
Inventory, December 31, 2020 2,936,750.00
Premium Inventory 3,185,000.00
Unused Postage
Factory Supplies Inventory 98,220.00
Prepaid Subscription
Prepaid Insurance 54,000.00
Prepaid Advertising
Investment in Bonds 765,540.00
Property, Plant and Equipment 8,121,400.00
Land
Building
Accumulated Depreciation – Building
Equipment
Accumulated Depreciation – Equipment 18,000.00
Other Assets 3,157,970.00
Accounts Payable 1,092,310.00
Salaries Payable
Notes Payable 300,000.00
Bank Loan – Current 400,000.00
Dividend Payable
Estimated Premium Liability
Litigation Payable
Other Liabilities 143,120.00
Ordinary shares, P 100 par value 12,620,.000.00
Share Premium 2,500,000.00
Retained Earnings, December 31, 2019 2,627,125.00
Sales 7,523,550.00
Sales Discount
Cost of Sales 4,764,420.00
Bank Charges
Subscription Expense 14,400.00
Postage Expense
Transportation Expense

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Repair Expense
Insurance Expense
Advertising Expense 72,000.00
Travel Expenses
Factory Supplies Expense
Bad Debt Expenses
Finance charges
Depreciation Expense
Premium Expense
Loss on sale of Equipment
Gain on sale of Equipment 40,000.00
Miscellaneous Income 36,000.00
Loss on Litigation
Organizational Cost Expense
Dividend Income 198,000.00
Interest Income
Interest Expense
Provision for Income Taxes
27,601,605.00 27,601,605.00

During the course of your audit, you obtained additional information relative to the accounts in the trial
balance, as follows:

CASH
1. In the audit of Cash, you found out that on December 29,2020, MLD recorded and wrote check payments
to merchandise suppliers amounting to P800,000. A number of checks amounting to P500,000 were
actually mailed on January 7, 2021.

2. One of the checks returned on January 20, 2021, dated December 31, 2020 for P25,000, for a 2020
operating expenses, was actually not written until January 5, 2021.This check appeared as one of the
outstanding checks in the company’s bank reconciliation as at December 31,2020.

3. On December 27, 2020, a customer check for P15,000 was returned by the bank and marked “NSF”.
Corresponding entry was made by the client on December 28, 2020. However, said check was
redeposited on December 29,2020 and was cleared by the bank on January 3, 2021. .

4. Verification of the other reconciling items in the bank reconciliation statement as of December 31, 2020
yielded the following findings:
a. A bank debit memo dated December 18, 2020 for P420,000 representing payment of a six-month loan
inclusive of interest of P20,000.
b. There are several bank deposits directly made by the customer in December, 2020 totaling P250,000.
c. Bank charges for December, 2020 amounting to P1,800.
d. Interest income on various savings account deposits, inclusive of 20% withholding tax, P56,250.

5. You conducted a surprise cash count of the company’s petty cash fund and undeposited collections at
8:20 a.m. on January 2, 2021. Your count disclosed the following:

Bills and coins

Bills Coins
P500.00 1 piece P10.00 10 pieces
100.00 25 pieces 5.00 18 pieces
50.00 32 pieces 1.00 186 pieces
20.00 46 pieces 0.25 38 pieces

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 Postage stamps (unused) - P 1,080

Checks
Date Payee Maker Amount
Dec.30 Cash Custodian P 1,200.00
Dec 30 MLD Corporation SLV, Inc. 14,000.00
Dec 31 MLD Corporation Aris Yu, sales manager 1,680.00
Dec 31 MLD Corporation MSU Corp. 17,800.00
Dec 31 MLD Corporation Atlas, Inc. 8,300.00
Dec 31 Tsina Trading MLD Corporation 27,000.00

Unreimbursed vouchers
Date Payee Description Amount
Dec. 23 Aris Yu, sales manager Advance for trip to Iloilo City P 20,000.00
Dec. 28 Central Post Office Postage stamps 2,500.00
Dec. 29 Messengers Transportation 780.00
Dec. 29 Bravo, Inc. Computer repair 1,200.00

Other items found inside the cash box:

1. Unclaimed pay envelope of Vince King. Indicated on the pay slip is his net pay of P9,500.00. Your
inquiry revealed that Vince’s salary is mingled with the petty cash fund.

2. The sales manager’s liquidation report for his Iloilo City trip.
Cash advance received on Dec. 23 P 20,000.00
Less: Hotel accommodation, meals, etc. P 16,000.00
Bus fare for two 1,200.00
Cash given to Pedro, salesman 1,000.00 18,200.00
Balance P 1,800.00

Accounted as follows:
Cash returned by Pedro to the sales manager P 120.00
Personal check of the sales manager 1,680.00
Total P 1,800.00

Additional information:
1. The custodian is not authorized to cash checks
2. The last official receipt included in the deposit on December 30 is No. 4351 and the last official
receipt issued for the current year is No. 4355. The following official receipts are all dated
December 31, 2020.

O.R. No. Amount Form of Payment

4352 P 13,600.00 Cash
4353 17,800.00 Check
4354 3,600.00 Cash
4355 8,300.00 Check

3. The petty cash balance which is included in the cash balance is P25,000.00. The last
replenishment of the fund was made on December 22, 2020.

TRADING SECURITIES
MLD Corporation’s portfolio of Trading Securities includes the following on December 31, 2019:

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 Cost Fair Value
15,000 ordinary shares of Tango Co. P 477,000 P 417,000
30,000 ordinary shares of Golf Co. 546,000 570,000
P 1,023,000 P 987,000

All of the above securities have been purchased in 2019. In 2020, MLD Corporation completed and
recorded the following securities transactions:

March 1, 2020 - Received cash dividends of P1.20 per ordinary shares of Tango Co.
June 1, 2020 - Bought 1,800 ordinary shares of Whiskey Co. at P45 plus commission,
taxes, and other transaction costs of P1,650.
June 1, 2020 - Sold 15,000 shares of Tango Co. ordinary shares at P31, less brokerage
commission of P4,500. Cash was debited for the proceeds and the same
amount was credited to Marketable Securities.
August 31, 2020 - Received 20% stock dividends from Golf Co., market value per share was
P30. Marketable securities was debited for the amount of dividends
received. Dividend income was also credited for the same amount.
October 1,2020 - Sold 5,000 ordinary shares of Golf Co. for P25 per share. Marketable
securities was credited for the total amount of the proceeds.

The fair market value of MLD Corporation portfolio of trading securities on December 31,2020 were as
follows:
Golf Co. P 500,0001
Whiskey Co. 85,0002
P 585,000
1
Net of P6,500 estimated transaction costs that would be incurred on the sale of the securities.
2
Net of P1,500 estimated transaction costs that would be incurred on the sale of the securities.

ACCOUNTS RECEIVABLE
An analysis of the accounting records pertaining to account receivables account revealed the following:

1. Accounts receivable written off as uncollectible amounting to P41,400 was recorded as a debit to Bad
Debt Expense and a credit to Account Receivable.

2. On April 1, 2020, MLD Corporation assigned accounts receivable totaling P400,000 as collateral on a
P300,000, 16% note from RCBC Bank. The assignment was done on a non-notification basis. In
addition, to the interest on the note, the bank also receives a 2% service fee, deducted in advance on the
P300,000 value of the note. The accountant recorded the transaction by debiting cash amounting to
P300,000 and a credit to Note Payable of the same amount. Memorandum entry was also prepared
regarding the assignment of receivables. Collection of assigned accounts in April totaled P191,100, net
of 2% sales discount was recorded by a debit to cash and a credit to accounts receivable of the same
amount.

On May 1, 2020, MLD Corporation paid the bank the amount owed for April collections plus accrued
interest on the note to May 1,2020. The remaining accounts was collected by MLD Corporation during
May except for P2,000 account written off as worthless. No entry was prepared regarding the said
transactions.

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 On June 1, 2020 MLD Corporation paid the bank the remaining balance of the note plus accrued interest.
No entry was also prepared regarding the said transaction.

3. On December 5,2020, MLD Corporation sold its account receivable (net realizable value, P260,000) for
cash of P230,000. Ten percent of the proceeds was withheld by the factor to allow for possible customer
returns and other account adjustments. The related allowance for bad debts is P40,000. The entry that
was recorded pertaining to the transaction was a debit to cash of P230,000 and a credit to account
receivable for the same amount.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

Based on the analysis of the collectability of the outstanding receivables of the company, this account
should be adjusted to 10% of account receivable – trade.

NOTES RECEIVABLE
On January 1, 2020, MLD Corporation sells its equipment with a carrying value of P160,000, (related
accumulated depreciation is P18,000). The company receives a non-interest bearing note due in 3 years with a
face amount of P200,000. There is no established market value for the equipment. The prevailing interest rate
for a note of this type is 12%. The accountant made the following entry relative to this transaction:
Note Receivable P 200,000
Property, Plant & Equipment P 160,000
Gain on Sale of Equipment 40,000

INVENTORIES
You observed the physical inventory of goods in the warehouse on December 31, 2020 and were
satisfied that it was properly taken. Shown below are portions of the company’s Sales and Purchase ledger
accounts:
Sales
Date Reference Amount
12/28/2020 SI No. 835 P 25,680
12/28/2020 SI No. 836 14,196
12/28/2020 SI No. 837 11,439
12/31/2020 SI No. 839 65,436
12/31/2020 SI No. 840 81,122
12/31/2020 SI No. 841 76,434
(SI = Sales Invoice)

Purchases
Date Reference Amount
12/28/2020 RR No. 949 P 14,500
12/30/2020 RR No. 951 26,700
12/31/2020 RR No. 952 34,550
12/31/2020 RR No. 953 14,675
(RR = Receiving Report)

When performing a sales and purchases cutoff test, you found the following:
a. All receiving report and sales invoices are prepared in strict numerical sequence.
b. The last receiving report number used in calendar year ended December 31, 2020 is RR. No. 953
c. The sale invoice number corresponding to the last shipment made in 2020 is SI No. 838.

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You also obtained the following additional information:
1. Included in the physical count at December 31 were inventories costing P25,000 that have been
purchased and received on RR No.950. As of December 31, 2020, no vendor invoice has been received
for these inventories.

2. There were goods located in the shipping area of MLD Corporation on December 31, 2020, but were not
included in the physical count. These had been sold to LLD co. who had already paid for the goods. The
goods were picked up by LLD Co’s truck on January 3, 2021. The sale was recorded on SI No. 835.

3. At the close of business on December 31, 2020, there were two box cars standing on MLD Coporation’s
siding:
a) Boxcar 14344AA was unloaded on January 2, 2021. The receiving report for this merchandise
is RR No.953. The freight was paid by the vendor.

b) Boxcar 02126RR was loaded and sealed on December 31, 2020. The car was taken from
MLD’s Corporation siding on January 2, 2021. It contained a shipment of goods to CCC Co.
and was covered by SINo. 838. The sales price for this order was P65,000, and transportation
charges were to be paid by CCC Co.

4. Temporarily stranded on a distant railroad siding at December 31, 2020, was a boxcar of inventories en
route to FFF Company. This was covered by SI No. 836. The terms of this shipment were FOB
destination.

5. Goods in transit from a vendor at December 31, 2020, were received on RR No. 954. The terms of this
shipment were FOB destination. Freight charges of P1,500 were paid by MLD Corporation. However,
this P1,500 freight charge was deducted from the purchase price of P16,800.

PREPAID EXPENSES
The following transactions are found on the records of the MLD Corporation at the end of December 31,
2020. No adjusting entries were made on these transactions.

1. On May 1, 2020, a two-year subscription to the Industry Journal in the amount of P14,400 was paid.
Subscriptions expense was charged for the entire amount.

2. On June 1, 2020, the accountant recorded a debit to Prepaid insurance amounting to P54,000 for the
payment of one-year insurance premium for inventory.

3. A payment of P72,000 was recorded as a debit to Advertising expense for the payment on a 2021
advertising contract.

4. Physical inventory of factory supplies as of December 31,2020 amounted to P58,500.

LONG-TERM INVESTMENTS
On January 1, 2020, MLD Corporation purchased debt securities for cash of P765,540 to be held as
financial assets at amortized cost. The securities have a face value of P600,000, and they mature in 15 years.
The transaction was recorded by the accountant as a debit to Investment in Bonds for P765,540 and a credit to
cash for a similar amount. The securities carry fixed interest of 10% that is receivable semiannually, on June 30
and December 31. The prevailing market interest rate on these debt securities is 7% compounded
semiannually. There are no other entry being recorded except for the entry stated above.

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PROPERTY, PLANT AND EQUIPMENT
In your audit of the company’s book, you found out that land, buildings and equipment are recorded to
only one account “Property, Plant and Equipment”. Your analysis of this account for transactions that was
incurred during 2020, disclosed the following:
___________________Property,_Plant_and_Equipment__________________________
Date Particulars Debit Credit
January 1, 2020 Balance 178,000
1, 2020 Equipment sold 160,000
7, 2020 Organization fees 60,000
15, 2020 Land site and old building 945,000
30, 2020 Corporate organization costs 90,000
February 3, 2020 Title clearance fees 55,200
March 29, 2020 Cost of razing the building 60,000
April 1, 2020 Salaries of MLD Company executives 180,000
June 15, 2020 Stock bonus to corporate promoters,
6,000 ordinary shares, P50
per share market value 300,000
15, 2020 Real property tax 43,200
30, 2020 Cost of new building completed and
occupied on this date has an
estimated life of 20 years
without salvage value 5,250,000
October 1, 2020 Equipment Purchased 1,120,000

Additional Information:
a) MLD Corporation paid P60,000 for the demolition of the old building. It sold the scrap for P36,000 and
credited the proceeds to miscellaneous income.
b) MLD executives did not participate in the construction of the new building.
c) The property tax was for the period January 1 to June 30, 2020.

LIABILITIES
Your audit of MLD’s liabilities account revealed the following:

a) During 2020, under MLD Corporation’s marketing strategy program, the company sold 700,000 tetra
packs of one of its new product line known as “CHOKO M”. Each tetra pack contain one coupon. Each
customer i entitled to a stuff toy for every 10 coupons surrendered plus P40. MLD Corporation pays P60
per stuff toy and P5 for handling and shipping. MLD Corporation estimates that 70% of the coupons will
be redeemed, even though only 250,000 coupons had been processed and distributed during the year.
The accountant recorded only the purchase and the payment of the stuff toys by a debit to Premium
Inventory. No other entries relating to premiums were recorded during the year.

b) MLD is also involved on the following situations described below. It financial statements are authorized
for issue on March 20, 2021.

1. On November 3, 2020, a lawsuit was filed by a disgruntled customer who discovered a safety hazard
in one of MLD’s best-selling product. MLD’s lawyers feel it is probable that the company will be liable
for P50,000.

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 2. On December 5, 2020, MLD initiated a lawsuit seeking P1,000,000 in damages from a patent
infringement.

3. On January 5, 2020, inventory purchased FOB shipping point from a foreign country was detained at
that country’s border because of political unrest. The shipment is valued at P2,500,000. MLD’
lawyers have stated that it is probable that MLD will be able to obtain the shipment.

4. MLD Corporation is involved in a lawsuit resulting from a dispute with a customer. On January 28,
2021, judgment was rendered against MLD in the amount of P200,000. MLD Corporation plans to
appeal the judgment and is unable to predict its outcome though management believes that it will not
have a material adverse effect on the company.

5. On April 25, 2021, the Bureau of Internal Revenue (BIR) is in the process of examining MLD’s
Corporation’s tax returns for 2019, but has not proposed a deficiency assessment. Management
feels an assessment is reasonably possible, and if an assessment is made, an unfavorable
settlement of up to P500,000 is reasonably possible.

STOCKHOLDERS’ EQUITY
In your audit of the company’s books you found the following information relating to stockholders’ equity:

1. On January 1, 2019, MLD Corporation was authorized to issue 200,000 ordinary shares with par
value of P 100 per share. 100,000 ordinary shares were sold for cash at P125 per share.

2. On June 1, 2020, The Board of Directors of MLD Corporation approved to issue stock rights to the
shareholders of record on January 1, 2020, entitling the shareholders to acquire one share at P100
par for every five shares held, the right to expire on December 31, 2020. A memorandum entry was
prepared to record the transaction.

Seventy five thousand (75,000) rights were exercised when the market value of the MLD’s ordinary
share was P130 per share. The rest of the rights were left to expire during the year. The accountant
recorded the transaction by debiting cash amounting to P1,500,000 and a credit to Ordinary shares of
the same amount.

3. On October 1, 2020, MLD Corporation acquired an equipment by issuing its own 10,000 ordinary
shares. At the time of acquisition, the fair value of the equipment is P800,000 and the share is
quoted at P112 per share. The equipment had an estimated life of 10 years and a salvage value of P
60,000. The accountant recorded the transaction as:
Equipment P 1,120,000
Ordinary shares P1,120,000

4. On December 31, 2020, MLD Corporation declared dividends on ordinary shares payable on March
31, 2021. The company decided to give the shareholders a choice between a total cash dividend of
P2,000,000 or a property dividend in the form of noncash assets from the Other Assets with carrying
amount of P2,500,000 and a fair value less cost to distribute of P3,000,000. MLD estimated that 70%
of the shareholders will take the option of the cash dividend and 30% will elect the noncash assets.
A memorandum entry was prepared regarding the information.

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ANSWERS:
1. Adjusted cash balance 3,063,315.50
2. Discount on notes 57,644.00
3. Cash Count 42,980.00
4. Adjusted Building 5,250,000
5. Adjusted bal land 1,000,200.00
6. Retained Earnings 778,410.80
7. Travel Expenses ANG
8. Shortage due to manager 240.00
9. Checks 42,980.00
10. Net Amount of cash received 382,700.00
11. Adjusted a/r assigned 0
12. Cash received factoring 207,000.00
13. Petty cash fund 2,200.00
14. Unrealized gain trading 12,000.00
15. Undeposited collection 57,300.00
16. Gain or loss ordinary shares 43,500.00
17. Total Liability 4,771,930.00
18. Adjusted bal cost of sales 4,713,825.00
19. Book value equipment 1,093,500.00
20. Total inventory 3,012,345.00
21. Dividend income 198,000.00
22. Interest expense 25,400.00
23. Adjusted a/r trade 1,036,608.00
24. Adjusted ordinary shares ANG
25. Loss factoring of a/r 30,000.00
26. Interest expense assignment 5,400.00
27. AJE Petty cash ANG
28. Finance charges 6,000.00
29. Total cash shortage ANG
30. Estimated premium liability 600,000
31. Carrying value debt securities 759,016.00
32. Allow. Doubful acct 102,241.20
33. Total current assets 9,517,604.80
34. Adjusted sales account 7,286,362.00
35. Net amount from assignment 382,700.00
36. Trading securities 593,000
37. Net income 445,885.80
38. Gain or loss equipment ANG
39. Total interest income debt ANG
40. Adjusted notes payable ANG

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