Auditing Theories

1. Rose Ramos, CPA, is auditing the Financial Statements of Kapwa, Inc. for the year ended
January 31, 20X7. Rose has complied a list of possible risks, including both errors and
fraud that may result in the misstatement of Kapwa’s financial statements and a
corresponding list of internal control that, if properly designed and implemented, could
assist Kapwa in preventing or detecting the errors and fraud.

For each possible risk (possible errors and frauds) number 1 through 5, select one
internal control procedure from the given choices that, if properly designed and
implemented, most likely could assist Kapwa in preventing or detecting the errors and
irregularities.

Questions:
1. Customer’s check are credited to incorrect customer accounts.
a. Monthly statements are mailed to all customers with outstanding balances.
b. Shipping clerks compare good received from the warehouse with approved sales
orders.
c. Customer orders are compared with the inventory master file to determine
whether items ordered are in stock.
d. Daily summaries are compared with control totals of invoices.

2. Different customer accounts are each credited for the same cash receipt.
a. Total amounts posted to the accounts receivable ledger from remittance advices
are compared with the validated bank deposit slip.
b. Prenumbered credit memos are used for granting credit for goods returned.
c. Goods returned for credit are approved by the supervisor of the sales
department.
d. Remittance advices are separated from the checks in the mailroom and
forwarded to the accounting department.

3. Customer’s checks are properly credited to customer accounts and are properly
deposited, but errors are made in the recording receipts in the cash receipts journal.
a. Total amounts posted to the accounts receivable ledger from remittance advices
are compared with the validated bank deposit slip.
b. The cashier examines each check for proper endorsement.
c. An employee, other than the bookkeeper, periodically prepares a bank
reconciliation
d. Validated deposit slips are compared with the cashier’s daily cash summaries.
 4. Customer’s checks are misappropriated after being forwarded to the cashier for
deposit.
a. Goods returned for credit are approved by the supervisor of the sales
department
b. Remittance advices are separated from the checks in the mailroom and
forwarded to the accounting department
c. The cashier examines each check for proper endorsement
d. Total amounts posted to the accounts receivable ledger from remittance advices
are compared with the validated bank deposit slip

5. Invalid transactions granting credit for sales returns are recorded.

a. Sales invoices are compared with shipping documents and approved customer
orders before invoices are mailed
b. Prenumbered credit memos are used for granting credit for goods returned
c. Remittance advices are separated from the checks in the mailroom and
forwarded to the accounting department
d. Goods returned for credit are approved by the supervisor of the sales
department

2. To provide assurance that each voucher is submitted and paid only once, an auditor
most likely would examine a sample of paid vouchers and determine whether each
voucher is
a. Supported by a vendor’s invoice
b. Stamped “paid” by the check signer
c. Prenumbered and accounted for
d. Approved for authorized purchases

3. In assessing control risk for purchases, an auditor vouches a sample of entries in the
voucher register to the supporting documents. Which assertion would this test of
controls most likely support?
a. Completeness
b. Existence or occurrence
c. Valuation or allocation
d. Rights and obligations
4. This caselette is designed to test your proficiency and competence in audit planning and
test of controls.

Perfecto, CPA, has just accepted an engagement to audit the financial statements of
Coco Forwarders, Inc. for the year ending December 31, 20X7. After obtaining an
understanding of the client’s design of the accounting and internal control systems and
their operations, he then proceeded in performing test of controls related to
substantive tests of production and warehousing cycle transactions and inventory.

The following questions relate to test of controls of the production and warehousing
cycle. Choose the best response.
Questions:

1. In a manufacturing company, which one of the following audit procedures would

give the least assurance of the valuation of inventory at the audit date?
a. Testing the computation of standard overhead rates
b. Examining paid vendor’s invoices
c. Reviewing direct labor rates
d. Obtaining information of inventories pledged under loan agreements

2. When auditing merchandise inventory at year-end, the auditor performs a purchase

cutoff test to obtain evidence concerning whether
a. All goods purchased before year-end are received before the physical inventory
count
b. Any goods held on consignment for customers are included in the inventory
balance
c. Any goods observed during the physical count are pledged or sold
d. All goods owned at year-end are included in the inventory balance

3. An auditor has accounted for a sequence of inventory tags and is now going to trace
information on a representative number of tags to the physical inventory sheets.
The purpose of this procedure is to obtain assurance that
a. The final inventory is valued at cost
b. All inventory represented by an inventory tag is listed on the inventory sheets
c. All inventory represented by an inventory tag is bona fide
d. Inventory sheets do not include untagged inventory items
 4. The physical count of a retailer’s inventory was higher than that shoes in the
perpetual records. Which of the following could explain the difference?
a. Inventory items had been counted, but the tags placed on the items had not
been taken off the items and added to the inventory accumulation sheets

5. An auditor’s tests of controls over the issuance of raw materials to production would
probably include
a. Reconciling raw materials and work-in-process perpetual inventory
b. Inquiring of the inventory custodian about the procedures followed when
defective materials are received from vendors
c. Observing that raw materials are stored in secure areas and that storeroom
security is supervised by a responsible person
d. Examining materials requisitions and reperforming client controls designed to
process and record issuances

5. No employee should be able to visit the corporate safe deposit box containing
investment securities without being accompanied by another corporate employee.
What consequence might follow if this rule were not enforced?
a. An employee could pledge corporate investments as security for a short-term
personal bank loan
b. An employee could steal securities and the theft would never be discovered
c. It would be impossible to get a fidelity bond on the employee
d. There would be no record of when company personnel visited the safe deposit box

6. In establishing the existence and ownership of a long-term investment in the form of

publicly traded shares, an auditor should inspect the securities or
a. Correspond with the investees company to verify the number of shares owned
b. Inspect the audited financial statements of the investee company
c. Confirm the number of shares owned that are held by an independent custodian
d. Determine that the investment is carries at the lower of cost or market

7. Items A to E are situations that James Dy, CPA has encountered during his audit of
Wellness Inc. Select as the best answer for each item the auditor would normally take.

A. Dy hired an actuary to assist in corroborating Wellness’ complex pension

calculations concerning accrued pension liabilities. The actuary’s findings are
reasonably close to Wellness’ calculations and support the financial statements.
B. Wellness holds note receivable consisting of principal and accrued interest payable
in 20X2. The note’s maker recently filed a voluntary bankruptcy petition, but
Wellness failed to reduce the recorded value of the note to its net realizable value,
which is approximately 20% of the recorded amount.

C. Dy was engaged to audit a client’s financial statements after the annual physical
inventory count. The accounting records were not sufficiently reliable to enable him
to become satisfied as to the year-end inventory balances.

D. Dy found an immaterial adjustment relating to inventory. Wellness has refused to

adjust the financial statements to reflect this immaterial item.

E. Wellness’ financial statements do not disclose certain long-term lease obligations.

Dy determined that the omitted disclosures are required by PFRS.

Questions:

1. The type of opinion that he ordinarily would issue in Situation A is

a. An adverse opinion
b. An “except for” qualified opinion
c. A disclaimer of opinion
d. An unqualified opinion

2. The report modification (if any) that would be necessary in Situation B is

a. Describe the circumstances in explanatory paragraph and modify the opinion
paragraph
b. Describe the circumstances in an explanatory paragraph without modifying the
three standard paragraphs
c. Describe the circumstances in an explanatory paragraph and modify the scope
and opinion paragraphs
d. Issue the standard auditor’s report without modification

3. The report modification (if any) in Situation C is

a. Issue the standard auditor’s report without modification
b. Describe the circumstances in an explanatory paragraph without modifying the
three standard paragraphs
c. Describe the circumstances in an explanatory paragraph and modify the scope
and opinion paragraphs
 d. Describe the circumstances in an explanatory paragraph and modify the
introductory, scope, and opinion paragraphs

4. In Situation D, the type pf report modification (if any) is

a. Issue the standard auditor’s report without modification
b. Describe the circumstances in an explanatory paragraph without modifying the
three standard paragraphs
c. Describe the circumstances in an explanatory paragraph and modify the opinion
paragraph
d. Describe the circumstances in an explanatory paragraph and modify the scope
and opinion paragraphs

5. In Situation E, the type of opinion that the auditor would ordinarily issue is
a. Either an “except for” qualified opinion or an adverse opinion
b. An unqualified opinion
c. Either an adverse opinion or a disclaimer of opinion
d. Either a disclaimer of opinion or an “except for” qualified opinion

8. Client No. 5: Advanced Research Corporation

During 20X2, the research staff of Advanced Research Corporation devoted its entire
efforts toward developing a new pollution-control device. All costs that could be
attributed directly to the project were accounted for as deferred charges and classified
on the balance sheet at December 31, 20X2, as a noncurrent asset. In the course of your
audit of the corporation’s 20X2 financial statements, you found persuasive evidence
that the research conducted to date would probably result in a marketable product. The
deferred research charges are significantly material in relation to both income and total
assets.

Question:
1. The appropriate audit report on the financial statements of Client No. 5 will contain
a. An unqualified opinion
b. An ‘except for’ qualified opinion
c. An adverse opinion
d. A disclaimer of opinion
 Auditing Problems

1. A surprise count of Pampanga Company’s imprest petty cash fund, carried on its records
at P5,000 was made on November 10,20X7.

The company acts as agent for an express company in the issuance and sale of money
orders. Blank money orders are held by the cashier for issuance upon payment of the
designated amounts by employees. Settlement with the express company is made
weekly with its representative, who calls at the Pampanga Co. office. At that time, he
collects for orders issued, accounts for unissued orders, and leaves additional blank
money orders, serially numbered.

The count of the items presented by the cashier as composing the fund was as follows:
The
Currency (bills & coins) P22,000
5,00
Cashed checks 0
7,40
Vouchers (made out in pencil and signed by recipients 0
2,60
NSF checks (dated June 10 and 15, 20X7) 0
Copy of petty cash receipt vouchers:
P2,00
Return of expense advance 0
3,00
Sale of money orders (No. A11 - 20) 1,000 0
Blank money orders claimed to have been purchased for P100
6,00
each from the express company (No. A21 - 29) 0
At the time of the count, there were also on hand the following:
Unissued money orders, No. A30 - 40
Unclaimed wage envelopes (sealed and amounts not shown)

following day, the custodian of the fund produced vouchers aggregating P4,000 and explained
that these vouchers had been temporarily misplaced the previous day. They were for wage
advances to employees.
 The following day, the custodian of the fund produced vouchers aggregating P4,000 and
explained that these vouchers had been temporarily misplaced the previous day. They
were for wage advances to employees.

Required:
1. Show the proper composition of the fund at November 10, 20X7.
2. Ilang-Ilang Company keeps all its in a checking account. Presented below are the
company’s bank reconciliation prepared at the end of May, the general ledger account
for cash, and summary of the company’s bank statement for June:

Ilang- Ilanng Company

Bank Reconciliation
May 31
Balance per bank statement P6,250
Add: Deposits in transit 225
6,475
418
Deduct: Oustanding checks P6,057
Correct cash balance

Balance per books P6,072

Deduct: Bank service charge 15
Correct cash balance P6,057

Cash

Balance, June 1 P 6,057 June disbursements P22,679

June receipts 26,182

Summary of Ilang-Ilang Company’s

Bank statement for June

Balance, June 1 P 6,250

Deposits shown for June 25,692
Note and interest collected during June 1,575
 Checks that cleared during June ( 25,707)
June service charge ( 17 )
Balance, June 30 7,793

Additional information
1. During June, Ilang-Ilang incorrectly recorded two checks. Check no. 507 was drawn
for P233 but recorded as P323; check no.521 was drawn for P180 but recorded as
P18. Both checls were issued in payment of accounts payable and cleared the bank
in June.
2. During June, the bank erroneously charged a P210 check of Kamia Company to Ilang-
Ilang Company’s account.
3. Of the P1,575 and interest collected by the bank during June, P75 represents
interest, all of which Ilang-Ilang earned during the current year. The company has
not yet recorded the collection.

Required:
1. Prepare a June 30 bank reconciliation.
2. Prepare journal entries to bring Ilang-Ilang Company’s accounting records up to
date.
3. What amount should Ilang-Ilang report as cash in the balance sheet dared June 30?

3. From inception of operations to December 31, 20X6, Dina Corporation provided for
uncollectible accounts receivable under the allowance method; provisions were made
monthly at 2% of credit sales; bad debts written off were charged to the allowance
account; recoveries of bad debts previously written off were credited to the allowance
account; and no year-end adjustments to the allocation account were made. Dina’s
usual credit terms are net 30 days.

The balance in the allowance for doubtful accounts was P130,000 at January 1, 20X7.
During 20X7 credit sales totaled P9,000,000, interim provisions for doubtful accounts
were made at 2% of credits sales, P90,000 of bad debts were written off, and recoveries
of accounts previously written off amounted to P15,000. Dina installed a computer
facility in November, 2017, and an aging of accounts receivable was prepared for the
first time as of December 31, 20X7. A summary of the aging is as follows:

Classified by Jul – Oct

month of sale Nov – Dec 20X7 Jan – June
 Prior to 1/1/X7 600,000
400,000 0%
130,000 1.5
Balance in each P2,270,000 8.0
Category 35.0
Estimated % 70.0
P1, 140,000 Uncollectible

Based on the review of collectability of the account balances in the “prior to 1/1X7
“aging category, additional receivables totaling P60,000 were written off as of December
31,20X7, Dina adopted the revised accounting standards in recognizing bad debts.
Instructions:
1. Prepare schedule analyzing the changes in the allowance for doubtful accounts for
the year ended December 31, 20X2. Show supporting computations in good form.
2. Prepare the journal entry for the year-end adjustment to the allowance for doubtful
accounts balance as of December 31, 20X7.

( AICPA adapted )

4. On May 21, 20X7, a fire destroyed the entire merchandise inventory on hand Natural
Corporation. The following information is available:

Sales, Jan. 1 through May 2, 20X7 - P360,000

Inventory, Jan. 1, 20X7 - 80,000
Merchandise purchases, January 1 through
May 2, 20X7 (including P40,000 of
goods in transit on May 2, 20X7
shipped F.O.B. shipping point) - 330,000
Mark - up percentage on cost - 20%

What is the estimated inventory on May 2, 20X7 immediately prior to the fire?

a. P70,000 c. P110,000
b. P82,000 d. P122,000

( AICPA adapted )
5. On audit engagement for 20X7, you handled the audit of fixed assets of A. Luna Copper
Mines. This mining company bought the exploration rights of Maharishi Exploration in
June 30, 20X7 for P7,290,000. Of this purchase price, P4,860,000 was allocated to
copper ore which had remaining reserves estimated at 1,620,000 tons. A. Lune Copper
Mines expects to extract 15,000 tons at ore a month with an estimated selling price of
P50 per ton. Production started immediately after some new machineries costing
P600,000 were bought on June 30, 20X7. These new machineries had an estimated
useful life of 15 years with a scrap value of 10% of cost after the ore machineries will
already be useless. Among the operating expenses of A. Lune Copper Mines at
December 31, 20X7 were:

Depletion Expense P 405,000

Depreciation machineries 40,000

Questions:

1. Recorded depletion expense was

a. Overstated by P90,000 d. Understated by P135,000
b. Understated by P90,000 e. None of these
c. Overstated by P135,000

2. Recorded depreciation expense was

a. Overstated by P10,000 d. Understated by P20,000
b. Understated by P10,000 e. None of these
c. Overstated by P20,000

6. On January 15, 20X7 the Saraw Company, a Philippine Company. Acquired machinery on
credit from a British company for £ 12,000. The company paid for the machine on
January 30, 20X7. The exchange rates on January 15 and 30 were P101.75 and P99,
respectively.

Required:
Record the journal entries for the acquisition and payment by the Saraw Company.

7. An account for a research project identified as AM423 included on the trial balance of
your client, Bohol Company. The account balance consists of the following charges:
 Salaries of research staff P 28,500
Patent acquired solely for use in project AM423 12,000
Patent acquired for use in several research
projects, including AM423 16,200
Cost of models 8,950
P 65,650

Intangible assets are amortized by the straight-line method over the shorter of the legal
life or estimated useful life. The company’s patents have generally been found to be
useful for approximately 10 years. You determined that both of the patents were
acquired in early 20X7 and that the cost of models and salaries were incurred
throughout 20X7.

Instructions:
Determine the items that should be presented in the Bohol’s balance sheet and income
statement on December 31, 20X7.

8. The Miller Corporation was established in 20X0. In 20X7 it adopted a pension plan for its
employees. On December 31, 20X7, the past service cost was determined to be
P500,000. Miller has elected to amortize past service cost over ten years and to fund
past service cost over ten years and to fund past service cost over fifteen years. The past
service cost of P500,000 as of December 31, 20X7 should be accounted for as a charge
to

a. Prior periods as a prior-period adjustment

b. Operation in 20X7
c. Operations ratably from 20X7 through 20X13
d. Operations ratably from 20X7 through 20X11

9. In your examination of the financial statements of Sikatuna Financing Company, you

learn that its president has a profit-sharing agreement with the corporation. The
agreement states that the president is to receive a bonus consisting of a basic amount
equivalent to 10% of the company’s net income before deduction if bonus but after
deduction of corporate income tax. In addition, the basic bonus will be increased b the
company’s tax savings because the total amount of bonus if deductible in computing the
company’s taxable income. The tax savings is the difference between the income taxes
the company would have paid if there were no bonus and the taxes the company must
pay after Sikatuna Financing Company registered a net income of P100,000 in 20X7
before deduction of the president’s bonus or the corporate income tax. The company is
 subject to a corporate income tax rate of 30% of its income after deducting the
president’s bonus.

Questions:
1. The total bonus due the president for 20X7 is

a. P7,216.49 c. P9,381.44
b. P3,313.43 d. P10,447.76

2. The corporate income tax for 20X7 is

a. P26,865.67 c. P27,805.97
b. P27,185.57 d. P27,835.05

3. The total tax savings from the president’s bonus ( to be added to his basic bonus of
10% of net income after taxes before deduction of bonus ) is

a. P -0- c. P2,194.03
b. P2,164.95 d. P3,134.33

4. The net income for 20X7 after deducting the president’s bonus and the corporate
income tax is

a. P62,686.57 c. P64,880.60
b. P63,432.99 d. P64,948.46

10. On October 1, 20X7 , the Alejo Company consigned one hundred television sets to B & B
Retailers, Inc. Each television set had a cost of P150.00. Freight on the shipment was
paid by Alejo Company in the amount of P200.

On December 1, 20X7, B & B Retailers, Inc. submitted an account sales stating that it had
solid sixty sets and it remitted the P12,840 balance due. The remittance was net of the
following deductions from the sales price of the television sold:

Commission - 20% of sales price

Advertising - P500
Delivery and installation charge -P100
 What was the total sales price of the television sets sold by B & B Retailers, Inc.?
a. P13,440 c. P16,800
b. P15,000 d. P17,000
( PhilCPA Adapted )

11. VR Company bought a building on July 1, 20X4, for P130,000. A fire insurance policy with
a face amount of P100,000 and a coinsurance clause of 80% was taken out on the
building. On February 2, 20X7, the building was partially destroyed by fire and the loss
was estimated at P120,000. Assuming that the fair market value of the building was
P180,000ath the date of the fire, how much should VR expect to recover from the
insurance company?

a. P80,000 c. P96,000
b. P83,333 d. P100,000

12. The following income statement items appeared on the adjusted trial balance of Saturn
Manufacturing Corporation for the year ended December 31, 20X7 ( P in 000s ): sales
revenue, P15,3000; cost of goods sold, P6,200; selling expenses, P1,300; general and
administrative expenses, P800; interest revenue, P85; interest expense, P180. Income
taxes have not yet been accrued. The company’s income tax is 40% on all items of
income or loss. These revenue and expense items appear in the company’s income
statement every year. The company’s controller, however, has asked for your help in
determining the appropriate treatment of the following nonrecurring transactions that
also occurred during 20X7 ( P in 000’s ). All transactions are material in amount.

1. Investments were sold during the year at a loss P220. Saturn also had unrealized
gains of P320 for the year on investment accounted for as securities available for
sale.

2. One of the company’s factories was closed during the year. Restructuring costs
incurred were P1,200.

3. An earthquake destroyed a warehouse causing P2,000 in damages.

 4. During the year, Saturn completed the sale of one of its operating divisions that
qualifies as a component of the entity. The division had incurred an operating loss of
P560in 20X7 prior to the sale, and its assets were sold at a gain of P1,400.

5. In 20X7, the company’s accountant discovered that depreciation expense in 20X6 for
the office building was understated by P200.

6. Foreign currency translation losses for the year totaled P240.

Questions:

1. The income from continuing operations after tax for the year amounted to

a. P2,091 c. P2,085
b. P3,485 d. P2,991

2. The income ( loss ) from discontinued operation net of tax expense is

a. P840 c. P405
b. P480 d. P504

3. Net income for the year amounted to

a. P2,091 c. P2,595
b. P3,795 d. P2,643

4. Other comprehensive income ( loss ) net of tax for the year amounted to

a. P48 c. P(48)
b. P192 d. P(192)

5. Earnings per share for the year amounted to

a. P2.16 c. P2.64
b. P1.74 d. P2.61

13. You have been engaged to audit the financial statements of Denmark Company. Upon
inspecting the books and records for Denmark Company for the year ended December
31, 20X7, you find the following data:
Item 1 A receivable of P6,400 from Hamilo Realty is determined to be uncollectible.
The company maintains an allowance for bad debts for such losses.

Item 2 A creditor, Joya Company has just been awarded damages of P35,000 as a result
of breach of contract by Denmark Company during the current year.
Nothing appears on the books in connection with this matter.

Item 3 A fire destroyed part of a branch office. Furniture and fixtures that cost P123,000
and had a book value of P82,000 at the time of the fire were completely
destroyed. The insurance company has agreed to pay P70,000 under the
provisions of the fire insurance policy.

Item 4 Advances of P9,500 to salespersons have been previously recorded as

Sales salaries expense.

Item 5 Machinery at the end of the year shows a balance of P199,600. It is discovered
that additions to this account during the year totaled P44,600, but of this
amount, P7,600 should have been recorded as repairs. Depreciation is to
be recorded at 10% on machinery owned throughout the year but at
one-half this rate on machinery purchased or sold during the year.

Questions:

1. Audit findings described in Item 1 would require

a. No adjusting entry
b. An adjusting entry credited Bad debts expense account
c. An adjusting entry debiting Bad debts expense account
d. An adjusting entry crediting the Accounts receivable account
2. Audit findings described in Item 2 would require
a. No adjusting entry
b. Only disclosure in the notes to financial statements
c. An adjusting entry crediting Lawsuit payable – Joya Company
d. An adjusting entry Loss from fire for P12,000.

3. Audit findings described in Item 3 would require

a. No adjusting entry
 b. Only disclosure in the notes to financial statements
c. An adjusting entry crediting Furniture and Fixtures for P82,000
d. An adjusting entry debiting Loss from fire for P12,000

4. Audit findings in Item 5 would require

a. No adjusting entry
b. Only disclosure in the notes to financial statements
c. An adjusting entry debiting Machinery for P7,600
d. An adjusting entry debiting Depreciation expense – Machinery for P17,350

5. If adjusting entries are made on audit findings described in Items 1 through 5,

Income before taxes would
a. Be reduced by P62,450
b. Be increased by P9,500
c. Not change
d. Be reduced by P71,950