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AUDITING PROBLEMS

PROBLEM NO. 1 You are engaged in the regular annual examination of the accounts and records of PRTC Manufacturing Co. for the year ended December 31, 2012. To reduce the workload at year end, the company, upon your recommendation, took its annual physical inventory on November 30, 2012. You observed the taking of the inventory and made tests of the inventory count and the inventory records. The companys inventory account, which includes raw materials and work -in-process is on perpetual basis. Inventories are valued at cost, first-in, first-out method. There is no finished goods inventory. The companys physical inventory revealed that the book inventory of P1,695,960 was understated by P84,000. To avoid delay in completing its monthly financial statements, the company decided not to adjust the book inventory until year-end except for obsolete inventory items. Your examination disclosed the following information regarding the November 30 inventory: a. Pricing tests showed that the physical inventory was overstated by P61,600. b. c. An understatement of the physical inventory by P4,200 due to errors in footings and extensions. Direct labor included in the inventory amounted to P280,000. Overhead was included at the rate of 200% of direct labor. You have ascertained that the amount of direct labor was correct and that the overhead rate was proper. The physical inventory included obsolete materials with a total cost of P7,000. During December, the obsolete materials were written off by a charge to cost of sales.

d.

Your audit also disclosed the following information about the December 31 inventory: a. Total debits to the following accounts during December were: Cost of sales P1,920,800 Direct labor 338,800 Purchases 691,600 The cost of sales of P1,920,800 included direct labor of P386,400.

b.

QUESTIONS: Based on the above and the result of your audit, determine the following: 1. Adjusted amount of physical inventory at November 30, 2012 a. P1,715,560 c. P1,845,760 b. P1,631,560 d. P1,722,560 Adjusted amount of inventory at December 31, 2012 a. P1,509,760 c. P1,502,760 b. P1,516,760 d. P1,425,760 Cost of materials on hand, and materials included in work in process as of December 31, 2012 a. P819,560 c. P728,560 b. P812,560 d. P942,760 The amount of direct labor included in work in process as of December 31, 2012 a. P618,800 c. P338,800 b. P232,400 d. P386,400 The amount of factory overhead included in work in process as of December 31, 2012 a. P 772,800 c. P464,800 b. P1,237,600 d. P777,600

2.

3.

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5.

PROBLEM NO. 2 PRTC Company's property, plant, and equipment, accumulated depreciation, and amortization balances at December 31, 2011 are: Accumulated depreciation P 672,900 367,500 114,326 108,000 P1,262,726

Land Buildings Machinery and equipment Automobile and trucks Leasehold improvements Totals

Cost P 275,000 2,800,000 1,380,000 210,000 432,000 P5,097,000

Additional information on depreciation, amortization methods, and useful lives follows: Depreciation method 150%-decliningbalance straight-line 150%-decliningbalance straight-line

Asset Buildings Machinery and equipment Automobile and trucks (all acquired after 2009) Leasehold improvements

Useful life 25 years. 10 years 5 years

Depreciation is computed to the nearest month. Salvage values of depreciable assets are immaterial except for automobiles and trucks which have estimated salvage values equal to 15% of cost. Other additional information: PRTC entered into a twelve-year operating lease starting January 1, 2009. The leasehold improvements were completed on December 31, 2008 and the facility was occupied on January 1, 2009. On January 6, 2012, PRTC completed its self-construction of a building on its own land. Direct costs of construction were P1,095,000. Construction of the building required 15,000 direct labor hours. PRTC's construction department has an overhead allocation system for outside jobs based on an activity denominator of 100,000 direct labor hours, budgeted fixed costs of P2,500,000, and budgeted variable costs of P27 per direct labor hour. On July 1, 2012, machinery and equipment were purchased at a total invoice cost of P325,000. Additional costs of P23,000 to rectify damage on delivery and P18,000 for concrete embedding of machinery were incurred. A wall had to be demolished to enable a large machine to be moved into the plant. The wall demolition cost P7,000, and rebuilding of the wall cost P19,000. On August 30, 2012, PRTC purchased a new automobile costing P25,000. On September 30, 2012, a truck with a cost of P48,000 and a carrying amount of P30,000 on December 31, 2011 was sold for P23,500. On November 4, 2012, PRTC purchased a tract of land for investment purposes for P700,000. PRTC thinks it might use the land as a potential future building site. On December 20, 2012, a machine with a cost of P17,000, a carrying amount of P2,975 on date of disposition, and a market value of P4,000 was sold to a corporate officer.

QUESTIONS: Based on the above and the result of your audit, compute for the following as of and for the year ended December 31, 2012: 6. Total depreciation a. P460,228 b. P462,678 Carrying amount of buildings a. P3,409,474 b. P3,761,974

c. P470,528 d. P461,528

7.

c. P3,028,774 d. P3,381,274

8.

Carrying amount of machinery and equipment a. P1,197,375 c. P1,243,925 b. P1,180,275 d. P1,222,075 Carrying amount of automobiles and trucks a. P68,472 b. P59,472

9.

c. P61,722 d. P52,722

10. Carrying amount of property, plant and equipment a. P5,637,371 c. P5,615,521 b. P5,608,771 d. P5,590,821 PROBLEM NO. 3 You noted the following items relative to the companys Intangible assets in connection with your audit of the PRTC Corporations financial statements for the year 2012. Franchise On January 1, 2012, PRTC signed an agreement to operate as franchisee of Clear Copy Service, Inc. for an initial franchise of P680,000. Of this amount, P200,000 was paid when the agreement was signed and the balance was payable in four annual payments of P120,000 each, beginning January 1, 2013. The agreement provides that the down payment is not refundable and no future services are required of the franchisor. The implicit rate for loan of this type is 14%. The agreement also provides the 5% of the revenue from the franchise must be paid to the franchisor annually. PRTCs revenue from the franchise for 2012 was P8,000,000. PRTC estimates the useful life of the franchise to be ten years. Patent On July 1, 2012, PRTC purchased a patent from the inventor, who asked P1,100,000 for it. PRTC paid for the patent as follows: cash, P400,000; issuance of 10,000 shares of its own ordinary shares, par P10 (market value, P20 per share); and a note payable due at the end of three years, face amount, P500,000, noninterest-bearing. The current interest rate for this type of financing is 12 percent. PRTC estimates the useful life of the patent to be ten years. Trademark PRTC purchased for P1,200,000 a trademark for a very successful soft drink it markets under the name POWER!. The trademark was determined to have an indefinite life. A competitor recently introduced a product that is in direct competition with the POWER! product, thus suggesting the need for an impairment test. Data gathered by the entity suggests that the useful life of the trademark is still indefinite, but the cash flows expected to be generated by the trademark have been reduced either to P40,000 per year (with a probability of 70%) or to P80,000 per year (with 30% probability). The appropriate risk-free interest rate is 5%. The appropriate riskadjusted interest rate is 10%.

QUESTIONS: Based on the above and the result of your audit, determine the following: (Round off present value factors to 4 decimal places) 11. Total expenses related to franchise in 2012 a. P503,914 b. P535,200

c. P448,950 d. P454,964

12. Carrying amount of franchise as of December 31, 2012 a. P549,644 c. P538,733 b. P494,680 d. P612,000 13. Carrying amount of patent as of December 31, 2012 a. P1,045,000 c. P860,310 b. P 955,900 d. P908,105 14. Total expenses related to the intangible assets in 2012 a. P662,759 c. P733,063 b. P711,709 d. P802,212 15. In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether the amortization period is reasonable in support of managements financial statement assertion of a. Valuation. c. Completeness. b. Existence or occurrence. d. Rights. PROBLEM NO. 4 You are conducting an audit of the PRTC Company for the year ended December 31, 2012. The internal control procedures surrounding cash transactions were not adequate. The bookkeeper-cashier handles cash receipts, maintains accounting records, and prepares the monthly bank reconciliations. The bookkeeper-cashier prepared the following reconciliation at the end of the year:

Balance per bank statement Add: Deposit in transit Note collected by bank Total Less outstanding checks Balance per general ledger

P350,000 P175,250 15,000 190,250 540,250 246,750 P293,500

In the process of your audit, you gathered the following: At December 31, 2012, the bank statement and general ledger showed balances of P350,000 and P293,500, respectively. The cut-off bank statement showed a bank charge on January 2, 2013 for P30,000 representing correction of an erroneous bank credit. Included in the list of outstanding checks were the following: a. A check payable to a supplier, dated December 29, 2012, in the amount of P14,750, released on January 5, 2013. b. A check representing advance payment to a supplier in the amount of P37,210, the date of which is January 4, 2013, and released in December, 2012. On December 31, 2012, the company received and recorded customers postdated check amounting to P50,000.

QUESTIONS: Based on the above and the result of your audit, answer the following: 16. The adjusted deposit in transit as at December 31, 2012 is a. P175,250 c. P225,250 b. P125,250 d. P125,000 17. The adjusted outstanding checks as at December 31, 2012 is a. P298,710 c. P209,540 b. P232,000 d. P194,790 18. The adjusted cash to be presented in the statement of financial position at December 31, 2012 is a. P235,460 c. P265,460 b. P250,460 d. P310,460 19. The cash shortage as of December 31, 2012 is a. P45,000 c. P60,000 b. P58,040 d. P 8,040 20. The net adjustment to the cash account as of December 31, 2012 is a. P43,040 c. P58,040 b. P60,000 d. P45,000 PROBLEM NO. 5 On January 1, 2012, PRTC Company sold land that originally cost P400,000 to Buyer Company. As payment, Buyer gave PRTC Company a P600,000 note. The note bears an interest rate of 4% and is to be repaid in three annual installments of P200,000 (plus interest on the outstanding balance). The first payment is due on December 31, 2012. The market price of the land is not reliably determinable. The prevailing rate of interest for notes of this type is 14% on January 1, 2012 and 15% on December 31, 2012. PRTC made the following journal entries in relation to the sale of land and the related note receivable: January 1, 2012 Notes receivable Land Gain on sale of land December 31, 2012 Cash Notes receivable Interest income P224,000 P200,000 24,000 P600,000 P400,000 200,000

PRTC reported the notes receivable in its statement of financial position at December 31, 2012 as part of trade and other receivables. QUESTIONS: Based on the above and the result of your audit, answer the following: 21. The correct gain on sale of land is a. P103,105 b. P 94,868 22. Profit for 2012 is overstated by a. P50,460 b. P31,130

c. P120,061 d. P200,000

c. P54,902 d. P 0

23. The entitys working capital at December 31, 2012 is overstated by a. P235,765 c. P182,476 b. P232,936 d. P 0 24. All of the following are examples of substantive tests to verify valuation of net accounts receivable except the a. Re-computation of the allowance for bad debts. b. Inspection of accounts for current versus non-current status in the statement of financial position. c. Inspection of the aging schedule and credit records of past due accounts. d. Comparison of the allowance for bad debts with past records. 25. Confirmation, which is a specific type of inquiry, is the process of obtaining a representation of information or of an existing condition directly from a third party. Two assertions for which confirmation of accounts receivable balances provides primary evidence are a. Completeness and valuation b. Rights and obligations and existence c. Valuation and rights and obligations d. Existence and completeness PROBLEM NO. 6 You were engaged by PRTC Corporation, a small and medium-sized entity, to audit its financial statements for the year 2012. During the course of your audit, you noted the following regarding its recent acquisitions of investments in equity securities: a) On 1 January 2012 the entity acquired 25 per cent of the equity of each of entities B, C and D for P10 million, P15 million and P28 million respectively. Transaction costs of 1 per cent of the purchase price of the shares were incurred by the entity.

b) On 2 January 2012 entity B declared and paid dividends of P1 million for the year ended 2011. c) On 31 December 2012 entity C declared a dividend of P8 million for the year ended 2012. The dividend declared by entity C was paid in 2013.

d) For the year ended 31 December 2012, entities B and C recognized profit of respectively P5 million and P18 million. However, entity D recognized a loss of P20 million for that year. e) Published price quotations do not exist for the shares of entities B, C and D. Using appropriate valuation techniques the entity determined the fair value of its investments in entities B, C and D at 31 December 2012 as P13 million, P29 million and P15 million respectively. Costs to sell are estimated at 5 per cent of the fair value of the investments. f) The entity has no subsidiaries and therefore does not produce consolidated financial statements.

In accordance with section 14.4 of the PFRS for SMEs, an investor shall account for all of its investments in associates using one of the following: (a) the cost model in paragraph 14.5, (b) the equity method in paragraph 14.8, or (c) the fair value model in paragraph 14.9. The entity is seeking your advice on the effect of each method on the carrying amount of the investment and its effect on profit or loss. QUESTIONS: Based on the above and the result of your audit, answer the following as of and for the year ended December 31, 2012: 26. If the entity measures its investments in associates using the cost model, the total carrying amount of the investments should be a. P40.25 million c. P39.25 million b. P53.28 million d. P39.50 million 27. If the entity measures its investments in associates using the cost model, the net amount to be recognized in profit or loss should be a. P(11.78) million c. P(11.03) million b. P(12.03) million d. P 2.25 million

28. If the entity measures its investments in associates using the equity method, the total carrying amount of the investments should be a. P52.03 million c. P42.75 million b. P43.00 million d. P43.75 million 29. If the entity measures its investments in associates using the equity method, the net amount to be recognized in profit or loss should be a. P(8.28) million c. P(7.53) million b. P(8.53) million d. P0.75 million 30. If the entity measures its investments in associates using the fair value model, the net amount to be recognized in profit or loss should be a. P5.72 million c. P2.87 million b. P5.47 million d. P4.00 million PROBLEM NO. 7 PRTC Corporation is selling audio and video appliances. The companys fiscal year ends on March 31. The following information relates to the obligations of the company as of March 31, 2012: Notes payable PRTC has signed several notes with financial institutions. The maturities of these notes are given below. The total unpaid interest for all of these notes amounts to P340,000 on March 31, 2012. Due date April 31, 2012 July 31, 2012 February 1, 2013 April 30, 2013 June 30, 2013 Amount P 700,000 900,000 800,000 1,200,000 1,500,000 P 5,100,000

Estimated warranties PRTC has a one-year product warranty on some selected items. The estimated warranty liability on sales made during the 2010 2011 fiscal year and still outstanding as of March 31, 2011, amounted to P252,000. The warranty costs on sales made from April 1, 2011 to March 31, 2012, are estimated at P630,000. The actual warranty costs incurred during 2011 2012 fiscal year are as follows: Warranty claims honored on 2010 2011 sales Warranty claims honored on 2011 2012 sales Total

P 252,000 285,000 P 537,000

Trade payables Accounts payable for supplies, goods, and services purchases on open account amount to P560,000 as of March 31, 2012. Dividends On March 10, 2012, PRTCs board of directors declared a cash dividend of P0.30 per ordinary share and a 10% ordinary share dividend. Both dividends were to be distributed on April 5, 2012 to ordinary shareholders on record at the close of business on March 31, 2012. As of March 31, 2012, PRTC has 5 million, P2 par value, ordinary shares issued and outstanding. Bonds payable PRTC issued P5,000,000, 12% bonds, on October 1, 2006 at 96. The bonds will mature on October 1, 2016. Interest is paid semi-annually on October 1 and April 1. PRTC uses the straight line method to amortize bond discount.

QUESTIONS: Based on the foregoing information, determine the adjusted balances of the following as of March 31, 2012: 31. Estimated warranty payable a. P252,000 b. P345,000 32. Unamortized bond discount a. P110,000 b. P100,000 33. Bond interest payable a. P 0 b. P300,000 34. Total current liabilities a. P6,445,000 b. P5,105,000 35. Total noncurrent liabilities a. P7,700,000 b. P7,500,000 PROBLEM NO. 8 The shareholders equity section of the PRTC Corporations statement of financial position as of December 31, 2011 is presented below: 12% Preference share capital, P100 par Ordinary share capital, P20 par Share premium preference Share premium ordinary Share premium treasury shares Retained earnings Total shareholders equity P 270,000 1,598,400 36,800 235,200 3,200 1,585,840 P3,729,440

c. P630,000 d. P882,000

c. P200,000 d. P 90,000

c. P150,000 d. P250,000

c. P5,445,000 d. P3,945,000

c. P7,590,000 d. P7,610,000

PRTC had 65,000 ordinary shares as December 31, 2010. The following shareholders equity transactions were recorded in 2011 and 2012: 2011 May 1 July 1 Jul. 31

Aug. 30

Dec. 31

Sold 9,000 ordinary shares for P24, par value P20. Sold 700 preference shares for P124, par value P100. Issued an 8% share dividend on ordinary shares. The market value of ordinary share was P30 per share. Declared cash dividends of 12% on preference shares and P3 per share on ordinary shares. Profit for the year amounted to P1,345,040.

2012 Feb. 1 May 1 May 31

Sold 2,200 ordinary shares for P30. Sold 600 preference shares for P128. Issued a 2-for-1 split of ordinary shares. The par value of the ordinary share was

2012 Sep. 1 Oct. 1 reduced to P10 per share. Purchased 1,000 ordinary shares for P18 to be held as treasury shares. Declared and paid cash dividends of 12% on preference shares and P4 per share on ordinary shares. Sold 1,000 shares of treasury shares for P22. Profit for the year amounted to P991,520.

Nov. 1 Dec. 31 QUESTIONS:

Determine the amounts, as required, in PRTC Corpor ations comparative financial statements as of and for the years ended December 31, 2011 and 2012. 36. Dividends paid to ordinary shareholders in 2012 a. P652,690 c. P652,960 b. P692,560 d. P656,960 37. Retained earnings as of December 31, 2012 a. P1,880,800 c. P1,892,000 b. P1,884,800 d. P1,888,000 38. Total equity as of December 31, 2012 a. P4,175,200 b. P4,171,200 39. Basic earnings per share for 2011 a. P17.12 b. P 8.21 40. Basic earnings per share for 2012 a. P7.40 b. P7.34 PROBLEM NO. 9 PRTC Corporation, a nonpublic entity, was incorporated on December 1, 2011, and began operations one week late closing the books for the fiscal year ended November 30, 2012, the controller prepared the following financial statements: PRTC Corporation Statement of Financial Position November 30, 2012 Assets Current assets: Cash Marketable securities , at cost Accounts receivable Allowance for doubtful accounts Inventories Prepaid insurance Total current assets Property, plant and equipment Less accumulated depreciation Property, plant and equipment, net Research and development costs Total assets

c. P4,182,400 d. P4,157,200

c. P 8.56 d. P18.49

c. P5.86 d. P5.81

P 150,000 60,000 450,000 ( 59,000) 430,000 __15,000 1,046,000 426,000 ( 40,000) 386,000 120,000 P1,552,000

Liabilities and Shareholders' equity Current liabilities: Accounts payable and accrued expenses Income taxes payable Total current liabilities Shareholders' equity: Share capital, P10 par value Retained earnings Total shareholders' equity Total liabilities and shareholders' equity

P 592,000 224,000 816,000 400,000 336,000 736,000 P1,552,000

PRTC Corporation Statement of Income For the Fiscal Year Ended November 30, 2012 Net sales Operating expenses: Cost of sales Selling and administrative Depreciation Research and development Income before income taxes Provision for income taxes Net income P2,950,000

1,670,000 650,000 40,000 30,000 2,390,000 560,000 224 000 P 336,000

PRTC is in the process of negotiating a loan for expansion purposes, and the bank has requested audited financial statements. During the course of the audit, the following additional information was obtained: a. The investment portfolio consists of short-term investments in marketable equity securities with a total market valuation of P55,000 as of November 30, 2012. Based on an aging of the accounts receivable as of November 30, 2012, it was estimated that P36,000 of the receivables will be uncollectible. Inventories at November 30, 2012 did not include work in process inventory costing P12,000, sent to an outside processor on November 29, 2012. A P3,000 insurance premium paid on November 30, 2012 on a policy expiring one year later was charged to insurance expense. PRTC adopted a pension plan on June 1, 2012 for eligible employees to be administered by a trustee. Based upon actuarial computations, the first twelve months' normal pension was estimated at P45,000. On June 1, 2012, a production machine purchased for P24,000 was charged to repairs and maintenance. PRTC depreciates machines of this type on the straight-line method over a five-year life with no salvage value, for financial and tax purposes. Research and development costs of P150,000 were incurred the development of a patent, which PRTC expects to be granted during the fiscal year ending November 30, 2013. PRTC initiated a five-year amortization of the P150,000 total cost during the fiscal year ended November 30, 2012. During December 2012, a competitor company filed suit against PRTC for patent infringement claiming P200,000 damages. PRTC's legal counsel believes that an unfavorable outcome is probable. A reasonable estimate of the court's award to the plaintiff is P50,000. The 40% effective tax rate was determined to be appropriate for calculating the provision for income taxes for the fiscal year ended November 30, 2012. Ignore computation of the deferred portion of income taxes.

b.

c.

d.

e.

f.

g.

h.

i.

QUESTIONS: Based on the above and the result of your audit, determine the following as of and for the fiscal period ended November 30, 2012: 41. Net income a. P253,260 b. P283,260 42. Current assets a. P1,084,000 b. P1,061,000 43. Total assets a. P1,484,200 b. P1,486,600 44. Total liabilities a. P833,340 b. P783,340 45. Total equity a. P683,260 b. P635,260 PROBLEM NO. 10 PRTC, Inc., a nonpublic enterprise, is negotiating a loan for expansion purposes and the bank requires audited financial statements. Before closing the accounting records for the year ended December 31, 2012, PRTC's controller prepared the following comparative financial statements for 2012 and 2011: PRTC, Inc. Statements of Financial Position December 31, 2012 and 2011 2012 2011 Assets Cash Trading securities Accounts receivable Allow. for doubtful accounts Inventories Property and equipment Accumulated depreciation Total assets Liabilities and Equity Accounts payable and accrued liabilities Estimated liability from lawsuit Share capital, P10 par Share premium Retained earnings Total liabilities and equity P 275,000 78,000 487,000 (50,000) 425,000 310,000 (150,000) P1,375,000 P150,000 78,000 392,000 (32,000) 307,000 217,000 (121,000) P 991,000

c. P235,260 d. P239,760

c. P1,079,000 d. P1,073,000

c. P1,489,200 d. P1,491,600

c. P855,840 d. P805,840

c. P639,760 d. P653,260

P 420,000 100,000 260,000 130,000 465,000 P1,375,000

P347,000 260,000 130,000 254,000 P 991,000

Net sales Operating expenses: Cost of sales Selling and admin. Depreciation Est. loss from lawsuit Profit

PRTC, Inc. Income Statements For the Years Ended December 31, 2012 and 2011 2012 2011 P1,580,000 P1,250,000 P 755,000 485,000 29,000 100,000 P1,369,000 P 211,000 P 690,000 365,000 18,000 P1,073,000 P 177,000

During the course of the audit, the following additional information was obtained: a. The trading securities were acquired on December 31, 2011. The securities have a fair value of P67,000 at December 31, 2012. In discussion with the company officials, it was determined that the doubtful accounts expense rate based on net sales should be reduced to 2% from 3%, effective January 1, 2012. As a result of errors in the physical count, inventories were overstated by P12,000 at December 31, 2011 and by P17,500 at December 31, 2012. On January 1, 2011, the cost of equipment purchased for P30,000 was debited to repairs and maintenance. PRTC depreciates equipment of this type by the straight-line method over a five-year life with no residual value. On July 1, 2012, fully depreciated equipment purchased for P21,000, was sold as scrap for P2,500. The only entry PRTC made was to debit cash and credit property and equipment for the scrap proceeds. The property and equipment (net) had a current cost of P250,000 at December 31, 2012. Advertising and promotion expense for the year ended December 31, 2011 includes the P25,000 cost of printing sales catalogs for a special promotional campaign held in January 2012. PRTC was named as a defendant in a lawsuit in October 2012. PRTC's counsel is of the opinion that PRTC has a good defense, and does not anticipate any impairment of PRTC's assets or that any significant liability will be incurred. Nevertheless, PRTCs management wished to be conservative and, therefore, established a loss contingency of P100,000 at December 31, 2012. QUESTIONS: Based on the above and the result of your audit, compute for the following: (Disregard income taxes) 46. Adjusted retained earnings as of January 1, 2012 a. P266,000 c. P285,000 b. P297,000 d. P291,000 47. Adjusted profit for the year ended December 31, 2012 a. P281,800 c. P287,800 b. P181,800 d. P306,800 48. Adjusted current assets as of December 31, 2012 a. P1,226,760 c. P1,154,900 b. P1,190,300 d. P1,202,300 49. Adjusted carrying amount of property and equipment as of December 31, 2012 a. P168,500 c. P178,000 b. P180,500 d. P192,500 50. Adjusted shareholders equity as of December 31, 2012 a. P962,800 c. P974,800 b. P950,800 d. P862,800

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