Auditing Cup_elimination.docx

AUDITING CUP – 19th RMYC ANSWER KEY ELIMINATION ROUND EASY 1. When inventory is material to the financial statements, the auditor should obtain sufficient appropriate audit evidence regarding its existence and condition by attendance at physical inventory counting unless impracticable. Where attendance is impracticable, due to factors such as the nature and location of the inventory, the auditor should: A. Take or observe some physical counts on an alternative date and, when necessary, perform tests of intervening transactions. B. Consider whether alternative procedures provide sufficient appropriate audit evidence of existence and condition to conclude that the auditor need not make reference to a scope limitation. C. Issue qualified or disclaimer of opinion. D. Issue qualified or adverse opinion Answer: B 2. In the audit of the ABC Company, a large branch that maintains its own bank account, cash is periodically transferred to the central account in Makati City. On the branch account’s records, bank transfers are recorded as debit to the home office clearing account and a credit to the branch account. Similarly, the home office account is recorded as a debit to the central bank account and a credit to the branch office clearing account. A. Lee is the head bookkeeper for both the home office and the branch bank accounts. Since he also reconciles the bank account, the senior auditor, B. Law, is concerned about the internal control weakness. As part of the year-end audit of bank transfers, B. Law asks you to schedule the transfers for the last few days in 2014 and the first few days of 2015. You prepared the following list Transfer No.

Amount of Transfer

Date recorded Date recorded in Date in the Home the Branch Deposited in office Cash Office Cash the Home Receipts Disbursements Office Bank Journal Journal Account 1 P120,000 12-27-14 12-29-14 12-26-14 2 260,000 12-28-14 01-02-15 12-28-14 3 140,000 01-02-15 12-30-14 12-28-14 4 110,000 12-26-14 12-26-14 12-28-14 5 150,000 01-02-15 01-02-15 12-28-14 6 280,000 01-07-15 01-05-15 12-28-14 7 370,000 01-04-15 01-06-15 01-03-15 The cash in bank account on the Home Office books should be increased by? A. P290,000 B. P570,000 C. P860,000 D. P430,000 ANSWER: B Transfer No. 3 Transfer No. 5 Transfer No. 6 Total

P140,000 150,000 280,000 P570,000

Date Cleared the Branch Bank Account 12-27-14 12-29-14 12-29-14 01-03-15 12-31-14 01-01-15 01-05-15

3. The Code of Ethics provides a Conceptual Framework for applying the fundamental ethical principles. This framework requires a professional accountant to: I. Identify threats to compliance with the fundamental principles II. Evaluated the significance of identified threats III. Apply safeguards for clearly insignificant/trivial identified threats A. I and II only B. I and III only C. II and III only D. I, II, and III Answer: A The Code of Professional Ethics provides the professional accountant to apply safeguards for other than clearly insignificant/trivial threats 4. The Notes Receivable account of ABC Company has a debit balance of P239,200 on December 31, 2014. There was no balance at the beginning of the year. Your analysis of the account reveals the following:  Notes amounting to P845,000 were received from customer during the year.  Notes of P416,000 were collected on due dates and notes amounting to P221,000 were discounted at the XYZ Bank. The Notes Receivable account was credited for the notes discounted.  Of the P221,000 notes discounted, P104,000 was paid on maturity date while a note for P31,200 was dishonored and was charged back to Notes Receivable account.  Cash of P33,000 was received as partial payment on notes not yet due. The amount received was credited to Liability on Partial Payments account.  A note for P50,000 was pledged as collateral for a bank loan.  Included in the Company’s cash account balance is a three-month note from an officer amounting to P8,000 which is over a month past due. Assuming that ABC Company will use a Notes Receivable Discounted account, the adjusted balance of the Notes Receivable account on December 31, 2014 is? A. P260,800 B. P323,200 C. P364,800 D. P175,000 Unadjusted Balance (P845,000 - P416,000 - P221,000 + P31,200) Partial collection recorded as Liability Notes Receivable discounted and still outstanding (P221,000 - P104,000 - P31,200) Dishonored Note Adjusted Balance

P239,200 (33,000) 85,800 (31,200) P260,800

5. ABC Company’s December 31, 2014 audited statement of financial position reported retained earnings of P150,000. Net income for 2014 was P85,000 and dividends of P60,000 were declared and paid in 2014. ABC Company’s accountant discovered that net income for 2013 had been understated by P25,000 due to error in recording depreciation expense in 2003. The amount of retained earnings per books as of December 31, 2013 amounted to? A. P150,000 B. P200,000 C. P125,000

D. P100,000 Answer and solution: A Retained earnings per book, December 31, 2013 (Squeeze) Adjustment for depreciation error in 2013 Retained earnings as adjusted, December 31, 2013 Net income in 2014 Dividends declared and paid in 2014 Retained earnings per audit, December 31, 2014

P100,000 25,000 125,000 85,000 (60,000) P150,000

6. Which of the following is the correct order of steps in the audit process? I. Perform tests of control II. Perform Preliminary Analytical Procedures III. Obtain client’s written representation IV. Prepare engagement letter V. Perform substantive tests VI. Perform Wrap up Analytical Procedures A. B. C. D.

IV, VI, I, V, II, III IV, VI, II, V, I, III IV, II, I, V, III, VI IV, II, I, V, VI ,III

Answer: D 7. ABC Company purchased a manufacturing plant building on January 1, 2011 for P2,600,000. The building has been depreciated using the straight-line method with 30-year useful life and 10% residual value. ABC’s manufacturing operations have experienced significant losses for the past two years, so ABC has decided that the manufacturing building should be evaluated for possible impairment. On December 31, 2020, ABC estimates that the building has a remaining useful life of 15 years, that the net cash flow from the building will be P100,000 per year and the fair value less costs to sell of the building is P760,000. What amount of impairment loss should be recognized in 2020? A. B. C. D.

P320,000 P0 P973,333 P1,060,000

Cost of building Less: Accumulated depreciation (P2,600,000 x 90% /30 x 10) Carrying value, December 31, 2010 Fair value less costs to sell Impairment loss

P2,600,000 780,000 1,820,000 (760,000) P1,060,000

AVERAGE 1. Which of the following is not considered an audit objective in auditing cash account? A. Cash is stated at its realizable value

B. Compensating cash balances are reported as other current assets C. Cash is properly classified, described, and disclosed in the financial statements, including notes, in conformity with GAAP D. The client has ownership rights in the reported cash Answer: B Compensating balances are classified according to the appropriate classification of the related borrowing, either current or noncurrent. 2. The following information was obtained from the audited financial statements of ABC Company for the year ended December 31, 2014: Operating income Selling, administrative and other operating expenses Finance cost 10% nonconvertible bonds Income tax rate

P3,500,000 1,800,000 250,000 2,500,000 30%

Additional data: a. There were 35,000 ordinary shares outstanding throughout the year. b. On January 1, 2014, there were options outstanding to purchase 20,000 ordinary shares at P30 per share. The average market price during the year was P40 per share. What is ABC’s diluted earnings per share for 2014? a) P26.93 b) P25.38 c) P17.14 d) P31.42 Solution: B Operating income Operating expenses Finance cost Income before tax Income tax (P1,450,000 x 30%) Number of ordinary shares: Actual number of ordinary shares Incremental shares: Option shares Assumed treasury shares Total DEPS (P1,015,000 / 40,000)

P3,500,000 (I,800,000) (250,000) 1,450,00 P1,015,000 35,000 20,000 (15,000)

5,000 40,000 P25.38

3. Pervasive effects on the financial statements are those that , in the auditors judgment: (choose the exception) A. Are not confined to specific elements, accounts or items of the financial statements B. If confined, represent or could represent a substantial proportion of the financial statements. C. In relation to the auditor’s opinion, are fundamental to users’ understanding of the financial statements. D. Are undetected due to an inability to obtain sufficient appropriate audit evidence.

Answer: C In relation to disclosures, are fundamental to users’ understanding of the financial statements. PSA705 - Modification to the Opinion in the Independent Auditors Report. 4. The following selected transactions occurred during the year ended December 31, 2014: Gross sales (cash and credit) Collections from credit customers, net of 2% cash discount Cash sales Uncollectible accounts written off Credit memos issued to credit customers for sales returns and allowances Cash refunds given to cash customers for sales returns and allowances Recoveries on accounts receivable written off in prior years (not included in cash received stated above)

P750,000 245,000 150,000 16,000 8,400 12,640 5.421

At year-end, the company provides for estimated bad debt losses by crediting the Allowance for Bad Debts account for 2% of its net credit sales for the year. The bad debt expense for 2014 is: A. B. C. D.

P11,832 P11,900 P11,732 P12,000

Solution: C Gross credit sales (P750,000 - P150,000) Less: Sales discount (P245,000 / 98% = P250,000 x 2%) Sales returns and allowances Net credit sales Bad debt expense (P586,600 x 2%)

P600,000 P5,000 8,400

13,400 P586,600 P11,732

5. Which of the following is not an example of a quality control procedure likely to be used by a public accounting firm to meet its professional responsibilities to clients? A. completion of independence questionnaires by all partners and employees B. review and approval of audit plan by the partner in charge of the engagement just prior to signing the auditor’s report C. evaluating professional staff after the conclusion of each engagement D. evaluating its integrity of management for each new audit client Answer: B Letter B is an example of quality control within the firm not a requirement by the professional Code of Ethics. 6. On July 1, 2014, ABC Company purchased 4,000 of the P1,000 face amount , 8% bonds of XYZ Corporation for P3,692,000 to yield 10% per annum. The bonds which mature on July 1, 2017, pay interest semiannually on January 1 and July 1. ABC Company classifies the securities as held to maturity.

What is the investment carrying value at December 31, 2015? A. P3,769,552 B. P3,741,200 C. P3,716,600 D. P3,795,320 Answer and solution: A (P3,692,000 x (1 + (10% / 2)) – (P4,000,000 x (8% / 2)) = P3,716,600 (P3,716,600 x (1 + (10% / 2)) – (P4,000,000 x (8% / 2)) = P3,742,430 (P3,742,430 x (1 + (10% / 2)) – (P4,000,000 x (8% / 2)) = P3,769,552 7. An auditor who uses the work of an expert may refer to the auditor’s expert in the auditor’s report if the: A. Expert is employed by the entity B. Expert’s work provides the auditor greater assurance of reliability C. Auditor expresses a qualified opinion or an adverse opinion related to the work of the expert. D. Auditor indicates a division of responsibility related to the work of the expert. Answer: C Refer to Par. A42 of PSA 620 DIFFICULT 1. The completion of the assembly of the final audit file after the date of the auditor’s report is an administrative process that does not involve the performance of new audit procedures or the drawing of new conclusions. Changes may, however, be made to the audit documentation during the final assembly process if they are administrative in nature. Examples of such changes include: I. Deleting or discarding superseded documentation II. Sorting, collating and cross-referencing working papers III. Performing test of details for samples on which the client recently gave supports IV. Signing off on completion checklists relating to the file assembly process V. Documenting audit evidence that the auditor has obtained, discussed and agreed with the relevant members of the audit team before the date of the auditor’s report A. I and II only B. I, II and IVonly C. I, II, IV and VI only D. I, II, III, IV and VI Answer: C. Performing additional procedures is prohibited even if the samples were selected beforehand. 2. ABC Company applies the allowance method to value accounts receivable. The Company estimates its bad debts based past experience, which indicates that 1.5% of the net credit sales will be uncollectible. Its total sales for the year ended December 31, 2015 amounted to P400,000. After a thorough evaluation of the accounts receivable from XYZ Company amounting to P20,000, ABC Company has decided to write off this account before year-end adjustments are made. Shown below are ABC Company’s account balances as at December 31, 2015, before any adjustments and the P20,000 write off. Sales Accounts receivable

P4,000,000 1,500,000

Sales discounts Allowance for bad debts Sales returns and allowances Bad debt expense

250,000 33,000 350,000 0

ABC Company has decided to value its accounts receivable using the balance sheet approach as suggested by its external auditors. Presented below is the aging of accounts receivable subsidiary ledger amounts as at December 31, 2015. Account DEF Company GHI Company KLM Company NOP Company QRS Company Total

Balance P100,000 256,000 654,000 50,000 420,000 P1,480,000

Less than 60 days P100,000 180,000 500,000

61 – 90 days

91 – 120 days

Over 120 days

P76,000 154,000 P50,000

P780,000

P230,000

P420,000 P420,000

99%

95%

85%

% Collectible

P50,000 60%

The final entry to adjust the allowance for bad debts account is: A. B. C. D.

Bad debt expense Allowance for bad debts Bad debt expense Allowance for bad debts Bad debt expense Allowance for bad debts Allowance for bad debts Bad debt expense

P44,300 P44,300 P45,000 P45,000 P24,300 P24,300 P24,300 P24,300

Answer and Solution: A Bad debt expense Allowance for bad debts Age A/R Balance Less than 60 days P780,000 61-90 days 230,000 91-120 days 420,000 Over 120 days 50,000 Required allowance Allowance balance (P33,000 + P45,000 – P20,000) Adjustment – increase in allowance

P44,300 P44,300 Rate 1% 5% 15% 40%

Amount P 7,800 11,500 63,000 20,000 102,000 58,000 P44,300

3. An auditor concludes that there is material inconsistency in the other information in an annual report to shareholders containing audited financial statements. The auditor believes that the financial statements do not require revision, but the client is unwilling to revise or eliminate the material inconsistency in the other information. Under these circumstances, what action would the auditor most likely take? A. Consider the situation closed because the other information is not in the financial statements. B. Issue and “except for” qualified opinion after discussing the matter with the clients audit committee. C. Disclaim an opinion on the financial statements after explaining the material inconsistency in a separate “other matter” paragraph.

D. Revise the auditor’s report to include a separate “other matter” paragraph describing the material inconsistency. Answer: D Since there is material inconsistency in the other information and the client is unwilling to revise the audited financial statement, per PSA706 – “Emphasis of Matter paragraphs and Other Matter Paragraphs in the Independent Auditors Report”, if the auditor considers it necessary to communicate a matter other than those that are presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report and this is not prohibited by law or regulation, the auditor shall do so in a paragraph in the auditor’s report, with the heading “Other Matter,” or other appropriate heading. The auditor shall include this paragraph immediately after the Opinion paragraph and any Emphasis of Matter paragraph, or elsewhere in the auditor’s report if the content of the Other Matter paragraph is relevant to the Other Reporting Responsibilities section. (Ref: Para. A5-A11) 4. ABC Company reported pretax incomes of P505,000 and P387,000 for the years ended December 31, 2009 and 2010, respectively. However, the auditor noted that the following errors had been made:  Sales for 2009 included amounts of P191,000 which had been received in cash during 2009, but for which the related goods were shipped in cash during 2010. Title did not pass to the buyer until 2010.  The inventory on December 31, 2009 was understated by P43,200.  The company’s accountant, in recording interest expense for both 2009 and 2010 on bonds payable made the following entry on an annual basis: Interest expense Cash

P75,000 P75,000

The bonds have a face value of P1,250,000 and pay a nominal interest rate of 6%. They were issued at a discount of P75,000 on January 1, 2009 to yield an effective rate of 7%. 

Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2009 and 2010. Repairs of P42,500 and P47,500 had been incurred in 2009 and 2010, respectively. In determining depreciation charges, ABC applies a rate of 10% to the balance in the Equipment account at the end of the year. What is the corrected pretax income for 2010? a) b) c) d)

P488,992 P480,042 P484,292 P575,392

Answer and solution:

A

Pretax income Sales revenue erroneously recognized in 2009 Understatement in 2009 ending inventory Understatement of bond interest expense (i) Ordinary repairs erroneously capitalized Overstatement of depreciation (ii) Corrected pretax income

2009 P505,000 (191,000) 43,200 (7,250) (42,500) 4,250 P311,700

(i) Year

Book value

Nominal

Effective

Discount

2010 P387,000 191,000 (43,200) (7,758) (47,000) 8,950 P488,992

2009 2010

of Bonds P1,175,000 1,182,250

Interest P75,000 75,000

Interest P82,250 82,758

Amortization P7,250 7,758

(ii) Overstatement of depreciation 2009 (P42,500/10) 2010 (P42,500/10) + (P47,000/10)

P4,250 P8,950

5. The easiest way to prevent the acceptance of unordered goods is to: A. Order only from approved vendors B. Always require a valid invoice before recording a payable C. Always require that a valid purchase order exists before goods can be accepted at time of delivery D. Always require receiving department personnel to purchasing department before accepting any goods Answer: C

6. The physical inventory of ABC Inc. as of December 26, 2014 totaled P945,000. You agreed on the December 26, 2014 count as the company has a good internal control system. In trying to establish the December 31 inventory, you noted the following transactions from the December 27 to December 31, 2014. Sales (30% mark-up on cost) Credit memos issued: For goods returned on: a. December 15 b. December 20 c. December 29 For goods delivered to customers not in accordance with specifications Credit memos received: For goods received on: a. December 10 b. December 26 c. December 28 Purchases: Placed in stock In transit, FOB shipping point In transit, FOB destination

P390,000

10,800 18,000 15,600 3,600

5,400 4,200 6,000 90,000 124,500 39,000

What is the inventory balance on December 31, 2014? a) P690,000 b) P780,000 c) P693,600 d) P865,500 Answer and solution: D Inventory per count, December 26, 2014

P945, 000

Add (deduct) transactions, December 27 – 31, 2014 Cost of goods sold (P390,000 / 130%) Goods returned by customers on December 29 (P15,600 / 130%) Goods returned to suppliers on December 28 Purchases placed in stock Purchases in transit, FOB shipping point Inventory balance, December 31, 2014

(300,000) 12,000 (6,000) 90,000 124,500 P865,500

7. Nesty Corp. had the following portfolio of financial instruments of the December 31, 2013. All securities were acquired at the beginning of 2013: Security Denomination/ Recorded Face Value Acquisition Cost Alpha shares 100,000 shares P5,250,000 Beta shares 40,000 shares 2,350,000 10%, Delta bonds, 3 years P2,000,000 par 1,951,126 Audit notes: a. Alpha shares were acquired and were designated as financial asset at fair value through profit/losses. The shares were acquired at P52.50 per share which included a P2.50 per share transaction cost. Half of the Alpha shares were sold at P58 per share on July 1, 2014. b. Beta shares were and were designated as financial asset at fair value through other comprehensive income/losses. The shares were acquired at P60 per share which included P1.25 per share transaction cost. 15,000 of these shares were sold on August 1, 2014 at P59 per share. c. The Delta bonds were acquired when the prevailing market rate of interest was at 11%. Interest are collectible every December 31. Half of the Delta bonds were sold on June 30, 2014 at P1.1M. d. Additional information on the securities are as follows: Security Fair value Dec. 31, 2013 Alpha shares P55/share Beta shares 57.50/share 10%, Delta bonds, 3 years 9% yield: P2,035,182

Fair value Dec. 31, 2014 P62/share 64/share 12% yield: ?

Assuming that the company’s business model has no objective of holding debt securities to collect contractual cash flows, what is the realized gain on sale of the Delta bonds in 2014? a. 63,067 c. 82,409 b. 113,067 d. 32,409 ANSWER: D CLINCHER 1. The use of a computer changes the processing, storage, and communication of financial information. A Computer Information Systems (CIS) environment may affect the following except: A. The accounting and internal control systems of the entity B. The overall objective and scope of an audit C. The auditor’s design and performance of tests of control and substantive procedures to satisfy the audit objectives D. The specific procedures to obtain knowledge of the entity’s accounting and internal control systems Answer: B CIS environment does not affect the overall objective and scope of an audit.

2. The following amounts are included in the general ledger of ABC Company as of December 31, 2014. Organization costs Trademarks Patents Discounts on bonds payable Deposits with advertising agency for ads to promote goodwill of company Cost of equipment acquired for various research and development projects Cost of developing a secret formula for a project that is expected to be marketed for at least 20 years

P72,000 45,000 225,000 105,000 30,000 320,000 240,000

On the basis of the information above, what is the total amount of intangible assets to be reported by ABC Company on its statement of financial position as of December 31, 2010? a) P342,000 b) P270,000 c) P510,000 d) P830,000 Solution: B Trademarks Patent Total

P45,000 225,000 P270,000

3. The policy of ABC Company is to debit bad debt expense for 3% for all new sales. The following are the Company’s sales and allowance for bad debts for the past four years. Year Sales Allowance for Bad Debts 2011 P3,000,000 P45,000 2012 2,950,000 56,000 2013 3,120,000 60,000 2014 2,420,000 75,000 The accounts written off in 2012, 2013, and 2014 amounted to? A. B. C.

2012 P99,500 77,500 11,000

2013 P97,600 89,600 4,000

2014 P87,600 57,600 15,000

D.

12,500

22,400

62,400

Answer and solution: B 2012 2013 Allowance balance, beginning P45,000 P56,000 Add: Estimated uncollectible (3% of sales) 88,500 93,600 Total allowance before write-offs 133,500 149,600 Less: Allowance balance, ending 56,000 60,000 Accounts written off P77,500 P89,600 4. ABC Company’s check register shows the following entries for the month of December: Date 2014 Dec. 1 5 7 11 26 29

Checks Beginning balance Deposit Check # 14344 Check # 14345 Deposit Check # 14346

Deposits

2014 P60,000 72,600 132,600 75,000 P57,600

Balance P89,300 154,300 120,800 106,800 155,800 147,200

P65,000 P32,500 14,000 49,000 8,600

ABC’s bank reconciliation for November revealed one outstanding check (no. 14343) for P12,000 (written on November 28) and one deposit in transit for P5,5550 (made on November 29). The following is from ABC’s bank statement for December 2014: Date 2014 Dec. 1 1 4 5 14 15 20 29 31

Checks Beginning balance Deposit Check no. 14344 Deposit Check no. 14345 Loan proceeds NSF checks Service charge Interest

Deposits P5,550

P32,500 56,000 14,000 500,000 7,600 1,000 3,600

Balance P95,750 101,300 68,800 124,800 110,800 610,800 603,200 602,200 605,800

Assume that all errors were committed by ABC Company not the bank. What is the adjusted cash balance on December 31, 2014? a) P663,800 b) P634,200 c) P748,200 d) P597,200 Solution: B Unadjusted balances Deposit in transit Outstanding checks (P12,000 + P8,600) Error in recording deposit (P65,000 – P56,000)

Book P147,200 (9,000)

Bank P605,800 49,000 (20,600)

Error in arithmetic for check no. 14344 Loan proceeds NSF check Interest Service charge Adjusted balances

1,000 500,000 (7,600) 3,600 (1,000) P634,200

P634,200