Auditing Problems You Can Use

CHATER 7 SUBSTANTIVE TESTS OF CASH
7-1. The quoted statement is not accurate. In their work on cash, auditors are primarily concerned with the risk of an
overstatement of the cash balance. The listing of a non-existent or fictitious check on the outstanding list would have
the effect of understating the clients cash position, because too large an amount for outstanding checks would be
deducted from the balance per bank, resulting in understatement of the adjusted balance.

The other element of the quoted statement relating to the auditors concern over the possible omission of a deposit in
transit is also in error. To omit a deposit in transit would cause an understatement of the year-end cash balance.

If the quoted statement were revised into acceptable form, it would read along the following lines: When auditors are
verifying a clients bank reconciliation, they are particularly concerned with the possibility that an outstanding check
may be omitted or that a non-existent deposit in transit may be included.

7-2. There is no assurance that the lapping activities of the cashier will be discovered during the annual audit. Since no
shortage exists as of the balance sheet date, the only procedure which might disclose the irregularities would be a
comparison of the individual checks listed on duplicate deposit tickets with the credits to customers accounts. Since a
test of this nature would probably not be made for more than a small sample of control listings it is likely that the
borrowing and subsequent restoration of borrowed funds might go undetected.

7-3. (a) Lapping is a defalcation in which a cash shortage is concealed by delaying the crediting of cash receipts to the
proper accounts receivable. The first step in the fraud is to withhold from a bank deposit cash remitted by a
customer. A few days later, because the customer must receive credit for his remittance, the first customers
account is credited with an amount from a remittance made by a second customer. The process requires the
continuous shifting of shortages from account to account and the crediting of subsequent receipts to the wrong
account receivable.

(b) The following audit procedures would be used to uncover lapping:
(1) Compare the detail of mailroom control listings (if prepared) to entries in the cash receipts journal, postings
to the accounts receivable subsidiary ledger, and the detail of authenticated duplicate deposit slips. This
procedure should indicate any delay in journalizing, posting, and/or depositing incoming cash receipts.
(2) If control listings are not prepared, compare the remittance advices received with customers checks to the
cash journal entries, postings to accounts receivable, and deposit slips. If the client stamps remittance
advices with the date received, particular attention should be given to comparing this date with the date of the
related journal entry and posting.
(3) Confirm accounts receivable and give close attention to exceptions made by customers about payment dates.
The confirmation procedure is better applied as a surprise at an interim date so that a person engaged in
lapping will not have been able to bring the lapped accounts up to date. If the confirmations are always
prepared at year-end, the confirmation procedure may be anticipated by the person doing the lapping and the
shortage given a different form such as kiting of checks. (Confirmation of accounts receivables has not been
discussed in this chapter, but some students may be familiar enough with this procedure to include it in their
answer.)

7-4. West, I nc.

The outstanding checks said by the controller to have been distributed after December 31 should be reversed to the
extent that they were actually distributed after that date. An actual overdraft should be revealed and not eliminated by
improper journal entries. The primary purpose of the reversal is to properly cut off the cash and show the proper cash
balance. Showing the correct cash balance eliminates window dressing; recorded but undistributed checks would
distort the current ratio by reducing both cash and accounts payable.

Substantive Tests of Inventories and Cost of Goods Sold 9-2
7-5. Cavite Company

Requirement (a) Adjusting Journal Entries - 12.31.05

AJE (1) Gas and oil 320
Supplies expense 260
Delivery expense 320
Repairs and maintenance 600
Advances to employees 400
Petty cash fund 1,900

(2) Advances to employees 200
Petty cash fund 200

(3) Accounts receivable - cashier 100
Petty cash fund 100

Shortage in PCF determined as follows:
Accounting:
Currency P 1,200
Coins 200
Check 1,400
Unreplenished vouchers 1,900
NSF check 200
Total 4,900
PCF per ledger 5,000
Shortage P (100)

(4) Cash in bank 450
Salaries payable 450

Requirement (b)

Cavite Company
Petty Cash Fund
12.31.05

Balance per ledger P 5,000
Add (Deduct) adjustments
AJE (1) ( 1,900)
(2) ( 200)
(3) ( 100)
Net adjustment ( 2,200)
Balance as adjusted P 2,800

7-6. Pampanga Company

Requirement (a)
Proper composition of the Fund, 11/10/06
Currency and coins P 2,200
Cashed checks 500
Vouchers 740
NSF checks 260
Total P 3,700
Less: Petty cash receipt vouchers
Return of expense advance P 200
Sale of money orders 100 300
Balance of Fund per count P 3,400
Balance of Fund per records 5,000
Shortage (P 1,600)

The cashier attempted to conceal the shortage by:

1)
Adding instead of deducting the cash received thereby overstating the accounting of the
fund by

P 600
2) Submitting blank money orders claimed to have been purchased 600
3) Submitting additional vouchers claimed to have been misplaced 400
Total P 1,600
Requirement (b)

Audit Procedures
a. Cashed checks
1. Examine checks as to payee, date, endorsements and subsequent deposit.
2. Determine if checks were cashed with prior approval of a responsible official.
b. Vouchers not yet replenished
1. Vouch supporting documents, invoices, etc.
2. Examine vouchers as to approval by authorized officials, signature of payee, etc.
c. NSF checks
1. Determine reason why NSF checks are still on hand.
2. Confirm directly with drawers.
d. Return of excess travel advance
1. Examine liquidation of travel advance as reported and determine accuracy of the amount returned.
2. Vouch supporting invoices.
e. Sale of money orders
1. Examine latest report of the Pampanga Co. to establish proper accountability.
2. Confirm directly with the Pampanga Co. all unreported money orders sold as well as unissued as of
November 10.
f. Vouchers subsequently presented
1. Examine vouchers as to date, approval, amount and nature of expenditures.
2. Confirm directly with employees those items representing wage advance.
g. Book balance of the Petty Cash Fund.
1. Trace to the general ledger the balance of the fund.

7-7.
Requirement (1) Bank Reconciliation, June 30
Bank Books
Balances, June 1 ................................................. P18,000 P30,170 (derived)
Additions:
Deposits in transit....................................... 16,000
Note and interest collected ......................... 1,860
Recording error (944 854) ...................... 90
Deductions:
Outstanding checks .................................... (6,000)
NSF check .................................................. (4,000)
Service charge ............................................ (120)
Correct cash balance .......................................... P28,000 P28,000

Requirement (2) Adjusting entry

Accounts receivable ........................................... 4,000
Service charge expense ...................................... 120
Accounts payable ....................................... 90
Interest revenue .......................................... 60
Notes receivable ......................................... 1,800
Cash ........................................................... 2,170

7-8. Form Company
Requirement (a)
Form Company
Bank Reconciliation Statement
6.30.06
Balance per bank statement P 27,000
Add: Cash on hand 9,228
Total 36,228
Less: Outstanding checks
Check no. 192 P 1,040
193 720
194 816
195 692 3,268

Balance per books P 34,700
Add: Note collected by bank 500
Total 35,200
Less: Shortage 2,240

Requirement (b) Shortage is P2,240.


Requirement (c)
The cashier attempted to conceal the shortage by:
(1) Understating the outstanding checks
(a ) Excluding check #192 P1,040
(b) Underfooting list of outstanding checks 200
(2) Adding instead of deducting note collected by bank
thereby covering up 1,000
Total P2,240

Requirement (d)
Suggestions to improve internal control:
(1) Bank reconciliation statement should be prepared by someone other than the cashier.
(2) Collections should be deposited intact.

7-9. J onas Company

Analysis of the bank statement and cash account will reveal the following:

a. Deposit in-transit, June 30:................................................ P2,700

b. Checks outstanding:
# 62 .................................................................................. P 900
# 68 .................................................................................. 1,300 P2,200

c. Interest earned on bank balance ........................................ P 100

Bank Reconciliation, June 30

Bank Book
Ending June balance ................. P22,580 Ending June balance ................. P22,980
Deposits in-transit ..................... 2,700 Interest earned ........................... 100
Checks outstanding:
#62 .................................... (900)
#68 .................................... (1,300)
Correct cash balance ................. P23,080 P23,080

The following journal entry must be made by Jonas Company:

Cash .......................................................................................... 100
Interest revenue ......................................................................... 100
7-10. Apple Company

Requirement (1)

(a) Deposits in-transit All deposits (#51 through #56) except #56 have been recorded by the bank; therefore, the
deposit in-transit is: #56, P3,500. This amount can be verified as: P2,000 + P190,000 P188,500 = P3,500.

(b) Checks outstanding: Inspection of the check numbers reveals that the following are outstanding: #121, P1,000;
#177, P2,500; #178, P3,000; and #179, P1,500; total, P8,000. This amount can be verified as: P6,000 + P198,000
P196,000 = P8,000.

Requirement (2)

Bank Books
Balances, December 1 ........................................ P76,550 P56,000
Additions:
Cash on hand .............................................. 400
Deposit in-transit (#56) .............................. 3,500
Note collected ............................................
Principal ............................................. 6,000
Interest................................................ 720
Funds received from foreign revenue ......... 10,000
Deductions:
Checks outstanding (#121, #177-179) ........ (8,000)
NSF check, Customer Belinda ................... (200)
United Fund transfer .................................. (50)
Bank service charge ................................... (20)
Correct cash balance .......................................... P72,450 P72,450

Requirement (3)

Journal entries from bank reconciliation:

(a) Cash ........................................................... 16,720
Note receivable .................................. 6,000
Interest revenue .................................. 720
Foreign revenue .................................. 10,000

(b) Account receivable, NSF check,
Customer Belinda ....................................

200

Contributions, United Fund ........................ 50
Expense, bank service charge ..................... 20
Cash ................................................... 270

7-11. Mindanao Company
Requirement (a)
Mindanao Company
Bank Reconciliation Statement
12.31.06
Bank Books
Unadjusted Balance P 88,489.12 P 58,983.46
Add (Deduct) Reconciling Items
a) Outstanding checks (32,108.42)
b) Receipts of 12.31.06 deposited 1.2.07 5,317.20
c) Service charge for November (3.85)
d) Proceeds of bank loan 9,875.00
e) Deposit of 12.23.06 omitted from bank statement 2,892.41
f) Returned check from Tome Co. (417.50)
g) Error by bank in entering 12.16.06 deposit, understated by 1.00
h) Check of Mina Mfg. Co. erroneously charged against Mindanao acct. 2,960.00
i) Note of J. Santos Co. collected by bank, 12.10.06 2,015.00
j) Erroneous bank debit memo 5,000.00
k) Error by bank in entering 12.4.06 deposit; overstated by ( 10.00)
l) Deposit of Mina Mfg. Co. erroneously credited to the companys
account

( 1,819.20) ___
P 70,722.11 P 70,452.11
Unlocated difference ___ 270.00
Adjusted balance P 70,722.11 P 70,722.11

Requirement (b) Adjusting Journal Entries: December 31, 2006
1. Bank charges 3.85
Cash in bank 3.85

2. Cash in bank 9,875.00
Interest expense 110.00
Prepaid interest 548.00
Loan payable 10,533.00

3. Accounts receivable 417.50
Cash in bank 417.50

4. Cash in bank 2,015.00
Bank charge 5.00
Notes receivable 2,000.00
Interest income 20.00
5. Cash in bank 270.00
Accounts receivable / Sales /
Miscellaneous income

270.00

7-12. Asia Envelope Company

ASIA ENVELOPE COMPANY
Proof of Cash
For the month ended 5-31-06

Balance M A Y Balance
5-1-06 Receipts Disbursement 5-31-06
P3,561.00 P42,700.17 P41,631.45 P4,629.72
Unadjusted book balance
Add (Deduct) Adjustments
Bank service charges
April 30 (6.00) (6.00)
May 31 6.80 (6.80)
NSF checks returned

April 30 (815.00) (815.00)
May 31 118.00 (118.00)
Draft collected by bank
April 1,500.00 (1,500.00)
May 202.00 202.00
Check No. 6129 erroneously
recorded in the check register
Correct Amount P87
Recorded as 78 9.00 (9.00)
Adjusted book balance P4,240.00 P41,402.17 P40,944.25 P4,697.92

Unadjusted bank balance P7,403.50 P41,776.27 P45,317.57 P3,862.20
Deposit in transit
April 30 950.00 (950.00)
May 31 925.40 925.40
Outstanding checks
April 30 (4,463.00) (4,463.00)
May 31 149.68 (149.68)
Checks of Asia Engine
Corp. erroneously charged
to company's account
April 349.50 (349.50)
May ________ _________ (60.00) 60.00
Adjusted bank balance P4,240.00 P41,402.17 P40,944.25 P4,697.92

7-13. Tarlac Company

(1)
Tarlac Company
Proof of Cash
For the month ended 12.31.06

Balance December Balance
11.30.06 Receipts Disbursements 12.31.06
Balance per bank statement P 45,240 P100,000 P135,240 P10,000
Add (Deduct) Reconciling items
Outstanding checks
November 30 (10,000) (10,000)
December 31 4,000 (4,000)
NSF checks returned in
December

(245)

245
Deposits in transit
November 30 2,500 (2,500)
December 31 3,500 3,500
Bank charges
November 20 20
December (25) 25
Check of another company
erroneously charged by bank
in November, corrected in
December

260

(260)

___

__
Balance per books P 38,020 P100,740 P 128,990 P 9,770

(2)
Adjusting Journal Entries - 12.31.06
1. Accounts receivable 245
Cash in bank 245

2. Bank charges 25
Cash in bank 25

(3)
Balance per books 12.31.06 P9,770
Less: AJE (1) P245
(2) 25 270
Balance as adjusted P9,500

7-14. Genius Company

a. Post-dated check report as accounts receivable because it is not negotiable until the date on the check.
b. Report as an account receivable because it is not a negotiable instrument at this time. Debit Accounts Receivable,
and credit Cash. If ultimately not collectible, write off as a bad debt.
c. Report as Note Receivable or as a short-term investment. It is inappropriate to report (or record) this as cash.
d. Include the P200 balance in petty cash in the balance reported as cash. Immediately replenish the fund for P168
and record it on December 31 as a debit to expenses (including the P1 cash short) and a credit to Cash.
Alternatively, an adjustment may be made debiting expenses for P168 and crediting petty cash fund on December
31, 2005.
e. Report the P30 of postage stamps as prepaid postage expense stamps are not cash.
f. Include the cashiers check in the balance because it will be accepted by banks for immediate deposit.
g. These checks should not be recorded as 2005 payments because the company still has full control of them.
h. The note and interest should not be included in the cash balance it has not been collected. The P20,000 should be
reported as a note receivable and interest of P450 (i.e., P20,000 x 9% x 3/12) should be accrued by a debit to
interest receivable and a credit to interest revenue for P450. However, if the bank reports that the note has been
collected on or before December 31 and a credit to the companys account has been made, this item may be
included in the cash balance.

7-15.
Balance Sheet Classification

Cash
Cash
Equivalent
ST
Investments

Other
Checking account X
Savings account X
Rare coins kept for long-term
speculation

X
Postdated checks received X
Money orders received X
Petty cash fund X
Treasury bills purchased when two
months remain in term

X

Compensating balance for a short-
term loan

X*

* shown separately

Balance Sheet Classification

Cash
Cash
Equivalent
ST
Investments

Other
Sinking fund to retire a bond in five
years

X
Certificate of deposit (six-month
term)

X

Short-term investment in
marketable equity securities

X

7-16. Cordial Company

Bank Reconciliation, 12.31.06
Bank Books
Unadjusted balance P350,000 P293,500
Deposit in transit (P175,250 - P50,000) 125,250 (1)
Post dated customers check recorded
on 12.31.06

( 50,000)

Note collected by bank 15,000
Outstanding checks
(P246,750 - P14,750 - P37,210)

(194,790)

(2)

Check payable to a supplier released on
Jan. 5, 2007

14,750

(6)
Check dated Jan. 4, 2007 recorded and
released in Dec., 2006

37,210

(6)
Erroneous bank credit corrected
on Jan. 2, 2007

____ (30,000)

__

As corrected 250,460 310,460
Unlocated difference (shortage) ___ ____ (60,000) (4)
Balance as adjusted P250,460 P250,460 (3)

Suggested answer to the multiple choice questions:
1. b 2. d 3. b 4. c 5. a 6. d

7-17. Pablo Corporation
PABLO CORPORATION
Proof of Cash
July 31, 2006

Reconciliation
6-30-06
July
Receipts
July
Disbursements
Reconciliation
7-31-06
Bank cash balance
Deposit in transit:
July
June
Undeposited cash
Outstanding checks:
July: #1345
#1353
#1354
June: #1082
#1086
#1087
Adjusted balance

Book cash balance
NSF check
Error
Note collected
Interest
Service charge
Adjusted balance
P13,031.78

146.73

(372.15)
(552.40)
(196.80)
P12,057.16

P12,057.16

P12,057.16
P10,051.17

1,098.51
(146.73)
472.50

P11,475.45

P10,460.45

1,000.00
15.00

P11,475.45
P5,326.52

27.00
13.23
14.24
(372.15)
(552.40)
(196.80)
P4,259.64

P4,102.69
113.15
36.00

7.80
P4,259.64
P17,756.43

1,098.51

472.50

(27.00)
(13.23)
(14.24)

P19,272.97

P18,414.92
(113.15)
(36.00)
1,000.00
15.00
(7.80)
P19,272.97
7-18. J ayce Corporation JAYCE CORPORATION
Proof of Cash
August 31, 2006

Reconciliation
7-31-06
August
Receipts
August
Disbursements
Reconciliation
8-31-06
Bank cash balance
Deposit in transit:
August
July
Undeposited cash
Outstanding checks:
August: #2265
#2269
#2270
July: #2150
#2151
#2152
Adjusted balance
Book cash balance
NSF check
Error in recording check
Note collected
Interest
Service charge
Adjusted balance
P 9,852.46

953.71

(345.26)
(156.72)
(97.43)
P10,206.76
P10,206.76

P10,206.76
P16,755.64

1,235.32
(953.71)
421.68

P17,458.93
P15,913.93

1,500.00
45.00

P17,458.93
P14,928.85

56.89
341.72
185.75
(345.26)
(156.72)
(97.43)
P14,913.80
P14,813.95
96.75
(9.00)

12.10
P14,913.80
P11,679.25

1,235.32

421.68

(56.89)
(341.72)
(185.75)

P12,751.89
P11,306.74
(96.75)
9.00
1,500.00
45.00
(12.10)
P12,751.89

7-19. Kirsten Lim, I nc.

1. April 1 Petty Cash ............................................................................................................................................ 200
Cash ..................................................................................................................................... 200

2. April 10 Cash Over and Short ............................................................................................................................ 2
Transportation-In ................................................................................................................................. 60
Supplies Expense ................................................................................................................................. 25
Postage Expense .................................................................................................................................. 33
ReceivablesEmployees .................................................................................................................... 17
Miscellaneous Expense ....................................................................................................................... 36
Cash (P200 P27) ............................................................................................................... 173

3. April 20 Petty Cash ............................................................................................................................................ 100
Cash ..................................................................................................................................... 100
Assuming no disbursements were made from April 20 to April 30 and the cashier made up the shortage of P2, the
answer is P300 (b).
7-20. Francos Auto Repair Service

Cash Over and Short ............................................................................................................................ 6.45
Accounts ReceivableEmployees ...................................................................................................... 74.00
(P40.00 + P34.00)
Neo Franco, Drawings* ....................................................................................................................... 170.00
Repair Expense .................................................................................................................................... 14.35
Postage Expense (P20.00 P2.90) ...................................................................................................... 17.10
Office Supplies .................................................................................................................................... 2.90
Cash (P300.00 P15.20) ..................................................................................................... 284.80
* Note: This debit might also be made to the capital account.

Answer: P15.20 (not among the choices; Faculty may add choice (e) P15.20)

7-21. Petty Cash, Bank Reconciliation

Balance per bank P6,522
Add:
Cash on hand 246
Deposit in transit 3,000 3,246
9,768

Deduct Checks outstanding (550)
Adjusted bank balance P9,218

Balance per books P8,315
Add: Note collected 930
9,245
Deduct Service Charge (27)
Adjusted cash balance, May 31 P9,218

P9,218 + P300 = P9,518 (a)

7-22. Powder I nc.

Powder, Inc.
Bank Reconciliation
November 30, 2006
Balance per bank statement, November 30, 2006 P56,274.20
Add:
Cash on hand, not deposited 1,915.40
58,189.60
Deduct:
Outstanding checks
#1224 P1,635.29
#1230 2,468.30
#1232 3,625.15
#1233 482.17 8,210.91
Correct cash balance, Nov. 30 P49,978.69

Balance per books, November 30, 2006 P49,178.22 *
Add:
Bond interest collected by bank 1,400.00
50,578.22
Deduct:
Bank charges not recorded in books P 27.40
Customers check returned NSF 572.13 599.53
Correct cash balance, Nov. 30 P49,978.69 (c)

*Computation of balance per books,
November 30, 2006
Balance per books, October 31, 2006 P 41,847.85
Add receipts for November 173,523.91
215,371.76
Deduct disbursements for November 166,193.54
Balance per books, November 30, 2006 P 49,178.22
CHAPTER 8 SUBSTANTIVE TESTS OF RECEIVABLES AND SALES

8-1. Tests of details of financial balances are designed to determine the reasonableness of the balances in sales, accounts
receivable, and other account balances which are affected by the sales and collection cycle. Such tests include
confirmation of accounts receivable, and examining documents supporting the balance in these accounts.

Tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal control
structure and to test the substance of the transactions which are produced by this cycle. Such tests would consist of
examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval
of credit.

The results of the tests of transactions will be used to affect the procedures, sample size, timing and particular items
selected for the tests of details of financial balances (i.e., an effective internal control structure will result in reduced
testing when compared to the tests of details required in the case of an inadequate internal control structure).

8-2. There are two common types of confirmations used for confirming accounts receivable: positive confirmations and
negative confirmations. A positive confirmation is a communication addressed to the debtor requesting him to
confirm directly whether the balance as stated on the confirmation request is correct or incorrect. A negative
confirmation is also a communication addressed to the debtor, but it requests a response only when the debtor disagrees
with the stated amount.

A positive confirmation is more reliable evidence because the auditor can perform follow-up procedures if a response is
not received from the debtor. With a negative confirmation, failure to reply must be regarded as a correct response
even though the debtor may have ignored the confirmation request.

Offsetting the reliability disadvantage, negative confirmations are less expensive to send than positive confirmations,
and thus more of them can be distributed for the same total cost. The determination of which type of confirmation to
be sent is an auditors decision, and it should be based on the facts in the audit. The following are the most important
circumstances where positive confirmations should be used:
1. There are a small number of large accounts which account for a significant portion of total accounts
receivable.
2. There are suspected conditions of dispute, inaccuracy, or irregularity. This would be the case when internal
controls are considered inadequate or if prior years audit test results are unsatisfactory.
3. The rules of certain regulatory agencies require them. This is the case for brokers and dealers in securities.
When the above conditions do not exist, it is acceptable to use negative confirmations, but negative
confirmations should not be used if the auditor confirmations are used, the auditor is using a reduced
control risk assessment in the audit of accounts receivable. It is also common to use negative confirmations
for audits of hospitals, retail stores, and other industries where the receivables are due from the
general public. In these cases, far more assurance is obtained from tests of internal control than from confirmations.

It is also common to use a combination of negative and positive confirmations by sending the positives to accounts
with large balances and negatives to those with small balances.

8-3. It is acceptable to confirm accounts receivable prior to the balance sheet date if the internal control structure is adequate
and can provide reasonable assurance that sales, cash receipts and other credits are properly recorded between the date of
the confirmation and the end of the accounting period. Other factors the auditor is likely to consider in making the decision
are the materiality of accounts receivable and the auditors experience in prior years. If the decision is made to confirm
accounts receivable prior to year end, it is necessary to test the transactions occurring between the confirmation date and
the balance sheet date by examining internal documents and performing analytical procedures at year end.


8-4. South Technologies, I nc.

(a) When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the auditors
purpose is to determine that the receivables were genuine when they were first recorded in the accounts. In some
fraud cases, fictitious accounts receivable have been created to cover up a shortage. Eventually these fictitious
receivables must be disposed of; one method is to write off the fictitious accounts as uncollectible.

(b) The South executive appears to believe the auditors are solely concerned with the collectibility of accounts and
notes receivable. In fact, the confirmation process is primarily intended to establish that the receivables are genuine
and that the customers (or makers of notes) exist. Other audit procedures are followed to determine collectibility.

8-5. The confirmation requests should go to the makers of the notes regardless of whether the notes have been discounted.
The act of discounting a note receivable does not reduce the importance of the note being genuine and collectible. A
company which discounts its notes receivable remains in a position of sustaining a loss if the makers of the notes fail to
make payment at the maturity dates.

8-6. (a) When customers fail to respond to positive confirmation requests the CPAs may not assume with confidence that
these customers reviewed the requests and found no disagreement and therefore did not reply. Some busy
customers will not take the time to review confirmation requests and will not respond; hence, obvious exceptions
may exist without being reported to the CPAs.

(b) If there is no response to a second request, the CPAs may mail a third request and possibly make telephone calls in
an effort to get a reply directly from the customer. When it becomes apparent that the confirmation program will
not produce further evidence, the CPAs should consider each remaining customer as to the size, nature, and age of
the balance and the apparent reason for the lack of a reply before they decide what additional work is necessary in
the circumstances. The CPAs should carry out the alternative audit procedures of examining customers purchase
orders or contracts, shipping documents and sales invoices of the client, and remittances by nonconfirming
customers received by the client subsequent to the balance sheet date. The auditors may also verify the existence,
location, and credit standings of the nonconfirming customers by reference to credit agencies or other sources
independent of the client.

8-7. North, I nc.

No, the matter remains unresolved. First, oral evidence from the client is never in itself sufficient; the auditors must
follow up to determine the reliability of the oral evidence. Second, payment of an account receivable is not
confirmation; the account might be fictitious, and the payment could have been made by a dishonest employee who
had created the fictitious account to conceal a cash shortage. The auditors must examine the customer purchase order
or contract, and copies of the sales invoice and shipping document, in support of the unconfirmed receivable. They
should also determine the genuineness of the customer by reference to the telephone directory or to credit agency
reports.

8-8. Montys Meat, Inc.

a. The workpaper does not include a description of the auditing procedures performed in confirming the
accounts. The workpaper is also incomplete in the following respects:

1) The workpaper does not state whether the auditor traced the ABC Grocery remittance of P3,000 to
November cash receipts.
2) The workpaper does not state whether the auditor examined the November 2 credit memo issued to Sari-Sari
Store.
3) The workpaper does not state whether the auditor traced the Lucenas Meat Market remittance to November
cash receipts.
4) The workpaper does not state whether and how the auditor obtained satisfaction regarding confirmation
requests not returned.
5) The workpaper does not state whether the auditor examined documentation for the Dianas Supper Club
order returned and received on October 31.
6) Rather than summarizing the confirmations returned without exception, as was done at the bottom of
Working Paper 1, these confirmations should have been listed separately.

b. 1) Sales P11,100
Accounts receivable P11,100
Inventory 8,600
Cost of goods sold 8,600
To reverse 2007 sale recorded in 2006.

2) Allowance for uncollectible accounts 1,277
Accounts receivable 1,277
To write off uncollectible account.
3) Sales returns and allowances 3,634
To record return of spoiled meat and
recognize loss in period in which incurred.
Meat not restored to inventory, inasmuch
as it was spoiled.
4) Sales 13,000
To correct error in recording customer
remittance as a sale.

5) Sales Returns 334
Accounts receivable 334
Inventory 250
Cost of goods sold 250
To record return and restore meat to inventory
because meat returned in good condition.


c. (See completed Exhibits 1.1 and 1.2 reproduced below and on the following page.)

Exhibit 1.1

Montys Meat, Inc.
Accounts Receivable - Trade
Aging Analysis
October 31, 2006

Conf. Past Due (Days)
No. Customer Balance Current 1-30 31-60 Over 60
1060 Culleys Meats P 1,330 P 1,330
1061 Jolly Roger Restaurant 466 P 466
1064 ABC Grocery 4,256 3,000 1,256
(Other) 329,433 280,763 33,467 P12,324 P 2,879
1602 Rudys Deli 378 378
1603 General Foods Grocers 13,468 13,000 468
1607 Kims Fresh Meats 2,334 1,074 1,260
1608 Dills Discount Grocery 12,469 12,469
1612 Dianas Supper Club 866 334 532
10/31 Balance per ledger P365,000 P 311,970 P 36,449 P13,234 P 3,347
Audit Adjustments P (29,345) P (28,068) P(1,277)
10/31 Audited balance P335,655 P 283,902 P 36,449 P13,234 P 2,070
#
Cash receipts 11/1 11/27 P(210,113) P (13,353) P 0 P 0 &

11/27 Outstanding P 73,789 P 23,096 P13,234 P 2,070

Estimated percent uncollectible 10% 25% 70% 100%

10/31 Estimated uncollectible
P 24,487
P 7,379 P 5,774 P 9,264 P 2,070

& Traced subsequent collections to November remittance advices.
# Obtained balances from subsidiary ledger after agreeing to general ledger control account.

Prepared by: Reviewed by:
Initial Date Initial Date


Exhibit 1.2

Montys Meat, Inc.
Accounts Receivable - Trade
Allowance for Doubtful Accounts
October 31, 2006

11/1/05 Balance per general ledger P28,000 #
11/1 - 10/31 Monthly provision 24,000 &
11/1 - 10/31 Write-offs (37,000) @
10/31/06 Balance per general ledger P15,000

AJE 2 (1,277)
P13,723
AJE 6 P10,777

10/31/06 Audited balance P24,500 ^

AJE 6

Bad debts expense P10,777
Allowance for doubtful accounts P10,777
To adjust allowance for doubtful accounts to amount

considered reasonable in the circumstances.

# Traced to last years WTB - audited balance
& Traced to standard journal entries
@ Examined documentation and discussed with credit manager and legal counsel
^ In light of aging analysis, the above balance, as adjusted, appears to be adequate.

Prepared by: Reviewed by:
Initial Date Initial Date

8-9. Makati Company

For all of the exceptions, the auditor is concerned about four principal things.
(a) Whether there is a client error. Many times the confirmation response differences are due to timing differences for
deposits in the mail and inventory in transit to the customer. Sometimes customers misunderstand the
confirmation or the information requested. The auditor must distinguish between those and client errors.
(b) The amount of the client error if any.
(c) The cause of the error. It would be intentional, a misunderstanding of the proper way to record a transaction, or a
breakdown of internal control.
(d) Potential errors in the sample not tested. The auditor must estimate the error in the untested population, based on
the results of the tests of the sample.

Suggested steps to clear each of the comments satisfactorily are:
1. (a) Examine supporting documents, including the sales invoices and applicable sales and shipping orders, for
propriety and valuation of the sales.
(b) Review the cash receipts books for the period after December 31, 2005, and note any collections from the
PDQ Company. The degree of internal control over cash receipts should be an important consideration in
determining the reliance that can be placed on the cash receipts entries. In addition, as there is no assurance
that collections after December 31 represent the payment of invoices supporting the December 31 trial
balance, consideration should be given to requesting a confirmation from the PDQ Company of the invoices
paid by their checks.
2. (a) The cause should be investigated thoroughly. If the credit was posted to the wrong account, it may indicate
merely a clerical error. On the other hand, posting to the wrong account may indicate lapping.
(b) Such a comment may also indicate a delay in posting and depositing of receipts. If upon investigation such is
the case, the company should be informed immediately so that it can take corrective steps.
3. This is a confirmation of the balance with an additional comment. Since the customer has given us the data, it is
preferable to check to see that the information agrees with the companys records. Such a procedure may disclose
misposting or delay in recording receipts.
4. This incomplete comment should raise an immediate question: does the customer mean paid before or paid after
December 31? Because the customers intent is unknown, this account should be reconfirmed and the customer
asked to state the exact date. Upon receipt of the second confirmation, the information thereon should be traced to
the cash receipts book.
5. The auditor should first evaluate how long it takes to ship goods to the customer in question. If it ordinarily takes
more than five days, there is no indication of error.
A comment of this type may indicate that the company may be recording sales before an actual sale has taken
place. The auditor should examine the invoice and review with the appropriate officials the companys policies.
Sales, cost of sales, inventories and accounts receivable may have to be adjusted if title has not passed to the buyer
as of December 31, 2005.
6. (a) Determine if such advance payment has been received and that it has been properly recorded. A review
should be made of other advance payments to ascertain that charges against such advances have been
properly handled.
(b) If the advance payment was to cover these invoices, the auditor should propose a reclassification of the
P1,350, debiting the advance payment account and crediting accounts receivable--trade.
7. (a) Examine the shipping order for indications that the goods were shipped and, if available, carriers invoice
and/or bill of lading for receipt of the goods.
(b) If it appears that goods were shipped, send all available information to the customer and ask the customer to
reconfirm. If the customer still insists that goods were never received, all data should be presented to an
appropriate company official for a complete explanation. This may indicate that accounting for shipments is
inadequate and consideration should be given to reviewing the procedures to determine if improvements can
be made.
(c) If the goods were not shipped, the auditor should recommend an adjustment reducing sales, cost of sales, and
accounts receivable, and increasing inventories.
8. This should be discussed with the appropriate officials and correspondence with the customer should be reviewed
to allow determination whether an adjustment should be made in the amount receivable or if an allowance for
doubtful accounts should be set up.
9. As title on any goods shipped on consignment does not pass until those goods are sold, the sales entry should be
reversed, inventory charged, and cost of sales credited if it is actually a consignment sale. Other so-called sales
should be reviewed and company officials queried to determine if other sales actual represent consignment
shipments; if so, the adjustment set forth in the preceding sentence should be made for all consignment shipments.
10. This is a noncurrent asset and should be reclassified to either deposit or prepaid rent. A review of other accounts,
especially those with round numbers, may disclose other accounts that should be so reclassified.
11. This may indicate a misposting of the credit or a delay in posting the credit. Comments under 2 above would also
apply to credits.
8-10. Ken Company

Requirement (a)
Ken Company
Accounts Receivable Aging Schedule
May 31, 2006

Age Category
Proportion
of
Total
Amount
in
Category
Probability
of
Non-Collection
Estimated
Uncollectible
Amount
Not yet due .680 P 816,000 .010 P 8,160
Less than 30 days past due .150 180,000 .035 6,300
30 to 60 days past due .080 96,000 .050 4,800
61 to 120 days past due .050 60,000 .090 5,400
121 to 180 days past due .025 30,000 .400 12,000
Over 180 days past due .015 18,000 .900 16,200
1.000 P1,200,000 P52,860

Requirement (b)
Ken Company
Analysis of Allowance for Doubtful Accounts
May 31, 2006
June 1, 2005 balance P 30,250
Bad debt expense accrual (3,000,000 x .04) 120,000
Balance before write-offs of bad accounts P150,250
Write-offs of bad accounts 108,750
Balance before year-end adjustment P 41,500
Estimated uncollectible amount 52,860
Additional allowance needed P 11,360

Debit Credit
Bad Debts Expense 11,360
Allowance for Doubtful Accounts 11,360

Requirement (c)
1. Steps to Improve the
Accounts Receivable Situation
2. Risks and Costs
Involved
Establish more selective credit-granting policies, such
as more restrictive credit requirements or more
thorough credit rating investigation.
This policy could result in lost sales and increased costs
of credit evaluation. Ken may be all but forced to
adhere to the prevailing credit-granting policies of the
office equipment and supplies industry.
Establish a more rigorous collection policy either
through external collection agencies or by Kens own
personal.
This policy may offend current customers and thus risk
future sales. Increased collection costs could result
from this policy.
Charge interest on overdue accounts. This policy may offend current customers and thus risk
future sales.
Insist on cash on delivery (COD) or cash on order
(COO) for new customers or poorer credit risks.
This policy could result in lost sales and increased
administrative costs.

8-11. Demo I nc.
Requirement (a)
DEMO INC.
Accounts Receivable
12-31-05

Balance A G I N G D I S T R I B U T I O N
Per General Per M o n t h s O u t s t a n d i n g
Ledger Subsidiary 0 - 1 1 - 3 3 - 6 over 6

Unadjusted Balances P197,000 P198,240 P93,240 P76,820 P22,180 P6,000
Add (Deduct) Adjustments:
AJE (2) to correct understatement of
accounts written off on October
31.

(200)

(3) to write off definitely uncollectible
accounts

(1,000)

(1,000)

(1,000)
(4) to reclassify advances from
customers

2,000

2,000

2,000

(5) to reclassify accounts with credit
balances

500

500

500

(6) to adjust general ledger balance
to agree with subsidiary balance

1,440

_______

_______

_______

_______

______
Balances as adjusted P199,740 P199,740 P95,240 P77,320 P22,180 P5,000

DEMO INC.
12-31-05
Balance per Ledger

P12,000.00
AJE (1) to correct error in recording bad debts recovery 324.00
(2) to correct understatement of accounts written off ( 200.00)
(3) to write off definitely uncollectible accounts ( 1,000.00)
(4) to adjust allowance to required balance (Schedule 1) ( 6,359.80)
Balance as adjusted P 4,764.20
Schedule 1: Computation of Required Allowance
Adjusted Required Allowance
Account Classification Total % Amount
0-1 month outstanding P 95,240 1 P 952.40
1-3 months outstanding 77,320 2 1,546.40
3-6 months outstanding 22,180 3 665.40
over 6 months outstanding 5,000 P2,000-50% 1,000.00
_______ P3,000-20% 600.00
Totals P199,740 P4,764.20

Requirement (b) Adjusting Journal Entries 12-31-05

(1) Bad Debts 324.00
Allowance for Doubtful Accounts 324.00
(2) Allowance for Doubtful Accounts 200.00
Accounts Receivable 200.00
(3) Allowance for Doubtful Accounts 1,000.00
Accounts Receivable 1,000.00
(4) Accounts Receivable 2,000.00
Advances from Customers 2,000.00
(5) Accounts Receivable 500.00
Customers accounts with credit balances 500.00
(6) Accounts Receivable 1,440.00
Sales 1,440.00
(7) Allowance for Doubtful Accounts 6,359.80
Bad Debts Expense 6,359.80

8-12. Tripoli Company

Requirement (1)

Accounts receivable, trade ....................................................... 40,000
Advances to suppliers .............................................................. 450
Due from officers ..................................................................... 2,500
Subscriptions receivable share capital ................................... 4,600
Expense advances to salespeople ............................................. 1,000
Accounts payable, trade (P19,250 P450)*..................... 19,250
Advances from customers on sales contracts ................... 450
Salaries payable................................................................ 3,300
Allowance for doubtful accounts ..................................... 500
Receivables (to close permanently) .................................. 23,050
Customers credit balances............................................... 2,000

Requirement (2)

Current assets:
Accounts receivable, trade ............................................... 40,000
Less allowance for doubtful accounts .............................. 500 P39,500
Creditors debit balances .................................................. 450
Due from officers** ......................................................... 2,500
Subscriptions receivable ordinary shares** .................. 4,600
Expense advances to salespeople ..................................... 1,000

Current liabilities:
Accounts payable, trade ................................................... 19,250
Customers credit balances............................................... 2,000
Cash advances from customers on sales
(not yet shipped)............................................................

450
Salaries payable................................................................ 3,300

* These amounts are netted against normal balances to reflect control balances; but if material in amount, they
should be reported separately on the balance sheet as indicated in Requirement 2.
** Considered as current assets only if currently collectible. All items are assumed to be material in amount.

8-13. Pearl Corporation

1. Estimated bad debt percentage based on year-end accounts receivable:
28.5%
#
2003 2004 2005 2006
Actual bad debts P 3,300
a
P 5,700
c
P 7,800
e
P 16,800
Credit Sales P90,000 P158,000 P210,000 P459,000
Outstanding receivables (year-end)
P 9,500
b

P 19,900
d

P 29,500
f

P 58,900
Percentage of outstanding
receivables

0.347

0.286

0.264

0.285
#

a
P2,500 + P500 + P300 = P3,300
b
0 + P90,000 - P78,000 - P2,500 = P9,500
c
P4,600 + P700 + P400 = P5,700
d
P9,500 + P158,000 - P8,500 - P134,000 - P500 - P4,600 = P19,900
e
Estimated. The bad debts written off in the third year following the sale have averaged about 7.8% [(P300 +
P400) (P3,300 + P5,700)] of the total actual bad debts in the previous 2 years. Therefore, the bad debts on
2005 sales of P6,200 and P1,000 are about 92.2% of the total bad debts expected on 2005 sales.
f
P19,900 + P210,000 - P200 - P14,200 - P178,800 - P300 - P700 - P6,200 = P29,500
2. Bad debts estimated as a percentage of year-end accounts receivable
P29,500 + P235,000 - P300 - P19,500 - P400 - P1,000 - P200,000
= P43,300
P43,300 x 0.285 = P12,340.50, or approximately P12,300. Criteria for recognition of bad debts or
impairment of receivables under PAS 39 should be applied.

8-14. Flores Corporation

Requirement (1)
Flores Corporation
Analysis of Changes in the
For the Year Ended December 31, 2006

Balance at January 1, 2006 P130,000
Provision for doubtful accounts (P9,000,000 x 2%) 180,000
Recovery in 2006 of bad debts written off previously 15,000
P325,000
Deduct write-offs for (P90,000 + P60,000) 150,000
Balance at December 31, 2006, before additional impairment loss P175,000
Increase in estimated uncollectible accounts during 2006 (P235,300 - P175,000) 60,300
Balance at December 31, 2006, adjusted (Schedule 1) P235,300

Schedule 1:
Computation of Allowance for Doubtful Accounts
at December 31, 2006
Aging category Balance Percent Doubtful accounts
November-December 2006 P1,140,000 2 P 22,800
July-October 600,000 10 60,000
January-June 400,000 25 100,000
Prior to 1/1/06 70,000
a
75 52,500
P235,300

a
P130,000 - P60,000

Requirement (2)
Flores Corporation
Journal Entry
December 31, 2006

Bad Debt Expense 60,300
To increase the allowance for doubtful accounts at December 31,
2006, resulting from evaluation of collectibility of remaining
receivables.

8-15. Visayas Company

Requirement (a)
Visayas Company
Accounts Receivable
12.31.06

Balance, 12.31.05 P 546,400
Add: Sales on account for the year 2,622,832
Total P3,169,232
Less: Collections during the year
- with discount (1) P2,050,859
- without discount (2) 848,118
Accounts written off 18,700
Credit memo for sales returns & allowances 37,000 2,954,677
Balance, 12.31.06 P 214,555

Total collections P2,857,960
Less: Accts paid w/ discount 2,009,842 ( 98% = P2,050,859) (1)
Accts paid by customers w/o discount
P 848,118

(2)

Requirement (b)

AJE (1) Doubtful accounts expense 6,599
Allowance for doubtful accounts 6,599

Supporting Analysis:

% allowance to AR 12.31.05 P 16,392 = 3 %
P546,400
Required % allowance to
AR 12.31.06 2/3 x 3% = 2 %
Required allowance 12.31.06
2% x P214,555 P4,291

Allowance for doubtful accounts balance, 12.31.05 P 16,392
Less: Accounts written off 18,700
P( 2,308)
Required balance, 12.31.06 4,291
Estimated bad debts expense for 12.31.06 P 6,599


8-16. Charry Company

Requirement (a) Adjusting Journal Entries

(1) Accounts Receivable 5,500
Customers accounts with credit balances 5,500
(P500 + P5,000)

(2) Sales 5,000
Accounts Receivable 5,000

(3) Subscriptions Receivable 15,000

(4) Deposit on Contract 15,000

(5) Claims Receivable 500
Accounts Receivable 500

(6) Advances to Employees 500

(7) Advances to Affiliated Company 10,000

(8) Advances to Supplier 5,000

Requirement (b) Balance Sheet Presentation 12-31-06

Current Assets
Accounts Receivable - Trade P59,500
Claims Receivable 500
Advances to Employees 500
Advances to Supplier 5,000
Investments
Advances to Affiliated Company 10,000
Other Assets
Deposit on Contract 15,000
Shareholders Equity
Subscribed Share Capital (net of subscriptions
receivable of P15,000) xxx

Supporting Analysis:

Charry Company
Accounts Receivable -Trade
12-31-06

Balance per ledger P105,000
AJE (1) To reclassify accounts with credit balances 5,500
(2) To reverse entry for consignment deliveries ( 5,000)
(3) To reclassify subscriptions receivable ( 15,000)
(4) To reclassify deposit on contract ( 15,000)
(5) To reclassify balance of claims from carrier for shipping
damages

( 500)
(6) To reclassify employees IOUs ( 500)
(7) To reclassify advances to affiliate ( 10,000)
(8) To reclassify advances to supplier ( 5,000)
Net adjustments ( 45,500)

If correct entries were made for the transactions given, the Accounts Receivable account would show the
following postings:

Accounts Receivable
Jan. 1 Balance P 56,000 Collections P615,000
Charge Sales 625,000 Write offs 3,500
Recoveries of Merchandise returns 2,500
accounts written off 1,000 Allowance for shipping
________ damages 1,500

P682,000 P622,500
________ Balance Dec. 31 59,500
P682,000 P682,000

8-17. The Preston Companies
(amounts in P millions)

Requirement (1)

(a) Prestons earnings would have increased (1 0.40) P105 million or P63 million in 2006. Net accounts receivable
and total assets would have been P105 million higher than actually reported in 2006. Ignoring differences
between tax and financial reporting, income tax payable would have increased by P0.40 (P105 million) or P42
million, and retained earnings would be greater by P63 million. This example illustrates the material effect
estimated bad debts can have on reported earnings and total assets.

(b) Under the allowance method, failure to write off an account has no effect on earnings (assuming a sufficient
balance exists in the allowance account), or any net balances in the balance sheet. Only the components of net
accounts receivable would be affected. Both gross accounts receivable and the allowance for doubtful accounts
would be overstated P0.6 million.

Requirement (2)

1998
Beginning allowance balance P183
Bad debt expense 105
Ending allowance balance (212)
Write-offs of accounts P 76

Requirement (3)

(a) The ratio of bad debt expense to operating revenue for the two years is: 2006, P105/P3,729 = 2.8%; 2005,
P81/P3,534 = 2.3%. This ratio appears relatively stable although is increasing.

(b) The composite rate of uncollectible accounts as a percentage of gross accounts receivable = ending allowance
balance/ending accounts receivable. The ratio for 2006 is P212 / (P951 + P212) = 18.2%, and for 2005 is P183 /
(P972 + P183) = 15.8%. This ratio is less stable and also is increasing.

(c) Bad debt expense is considerably higher than the write-offs in 2006. The firm has experienced an increase in
expected write-offs. Apparently the firm expects an increase in bad debts, which is partially an estimate of future
write-offs.

8-18. Rain Company

Requirement (1)

Present value of the note: P150,000 x (PV1, 12%, 3) (0.71178) = P106,767

Requirement (2)
Correction and Collection Schedule:
Note Receivable
Date Explanation and Interest Revenue Change Balance
1-1-2005 Recorded originally at face amount P150,000
12-31-2005 Correction to restate to present value P 43,233 106,767
12-31-2005 To accrue interest, P106,767 x 12% = P12,812 + 12,812 119,579
12-31-2006 To accrue interest, P119,579 x 12% = P14,349 + 14,349 133,928
12-31-2007 To accrue interest, P133,928 x 12% = P16,072* + 16,072 150,000
12-31-2007 Collection on face amount, debit Cash 150,000 0

* Rounded.

8-19.
1. d. The Josefina note is a short-term note and is reported at face value although the note can be recorded at
present value. The Nicole note is reported at present value: [(P20,000 + 5(0.3) (P20,000)] (PV1, 8%, 5) =
P23,000 (0.68058) = P15,653
2. c. The annual payment is computed as: P10,000 (PVA, 8%, 5) = P10,000 / 3.99271 = P2,505.
Discounting this stream of payments at 9% yields cash proceeds of: P2,505 (PVA, 9%, 5) = P2,505
(3.88965) = P9,744.
Total interest equals total payments less proceeds = 5 (P2,505) P9,744 = P2,781.
3. b. Interest receivable is recorded for one month.
4. c. Maturity value .............................................................................. P100,000
Discount P100,000 (0.10) (6/12) .................................................. (5,000)
Proceeds ....................................................................................... P 95,000

8-20. Luce Company

(1) AJE: Sales returns and allowances 30,000
Inventory 12.31.06 24,000
Cost of sales 24,000

Income will decrease by P6,000 if the above AJE is
made.

Ans. (c)
(2) AJE: Sales 10,000

Income was overstated by P10,000

Ans. (a)
(3) Actual number of units sold to Mr. Lazo was 320. P48,000
P150
Ans. (b)
(4) Correct receivable from
Mr. Lazo : 320 x P100 P 32,000
Per client 48,000
Overstatement P 16,000
Ans. (d)
(5) Accounts receivable from Mr. Sia is correctly stated because the goods are considered sold in 2006.
Ans. (a)
(6) Ans. (d)

8-21. ETC Co.
Adjusting Journal Entries
AJE 1. Cash 225,000
Other Current Liabilities (UCPB Overdraft) 225,000

2. Accounts Receivable 37,500
Cash 37,500

3. Cash 28,709
Accounts Payable 28,709

4. Notes Payable 67,500
Interest Expense 16,200
Cash 83,700

5. Cash BPI 25,000
Other Current Liabilities (UCPB Overdraft) 25,000

6. Cash SBTC 73,690

Cash
5.31.06

Per books P 15,825,000
AJE 1. 225,000
2. (37,500)
3. 28,709
4. (83,700)
5. 25,000
6. 73,690
Adjusted balance P16,056,199 (1) (c)

Accounts Receivable
5.31.06

Subsidiary Ledger General Ledger
P8,047,054 P7,868,029
AJE 2. 37,500 37,500
6. (73,690)
(375,215)
122,500
P7,831,839 P7,831,839 (2) (b)


Aging
Distribution

Subsidiary Ledger

%
Amount Estimated
to be Uncollectible
Current P1,737,690.00 + P122,500 = P1,860,190.00 x 2 = P 37,203.80
Past due:
1 30 P1,617,340.00 = 1,617,340.00 x 5 = 80,867.00
31 60 P1,437,706.50 = 1,437,706.50 x 10 = 143,770.70
61 90 P1,474,450.00 = 1,474,450.00 x 15 = 221,167.50
Over 90 P1,779,867.50 + P37,500
___________ P375,215 = 1,442,152.50

x 20

= 288,430.50
P8,047,054.00 P7,831,839.00 P771,439.50

8-22. Ling, I nc.
Requirement (1)

LING, INC.
Long-term Receivables Section of Balance Sheet
December 31, 2005

9% note receivable from sale of division, due in annual installments of
P500,000 to May 1, 2007, less current installment

P 500,000[1]
8% note receivable from officer, due December 31, 2007, collaterized
by 10,000 shares of Ling, Inc., ordinary shares with a fair value
of P450,000

400,000
Non-interest-bearing note from sale of patent, net of 15% imputed
interest, due April 1, 2007

84,105 [2]
Installment contract receivable, due in annual installments of P50,000
to July 1, 2009, less current installment

112,400 [3]
Total long-term receivables P1,096,505
(3) (a)
Requirement (2)

LING, INC.
Selected Balance Sheet Balances
December 31, 2005

Current portion of long-term receivables:
Note receivable from sale of division P500,000 [1]
Installment contract receivable 27,600 [3]
Total P527,600

Accrued interest receivable:
Note receivable from sale of division P 60,000 [4]
Installment contract receivable 11,200 [5]
Total P 71,200

Requirement (3)

LING, INC.
Interest Income from Long-Term Receivables
and Gains Recognized on Sale of Assets

Interest income:
Note receivable from sale of division P105,000 [6]
Note receivable from sale of patent 8,505 [2]
Note receivable from officer 32,000 [7]
Installment contract receivable from sale of land 11,200 [5]
Total interest income for year ended 12/31/05 P156,705

Gains recognized on sale of assets:
Patent P 37,600 [8]
Land 50,000 [9]
Total gains recognized for year ended 12/31/05 P 87,600

Explanation of amounts:

[1] Long-term Portion of 9% Note Receivable at 12/31/05
Face amount, 5/1/00 P1,500,000
Less: installment received 5/1/05 (500,000)
Balance, 12/31/05 P1,000,000
Less: installment due 5/1/06 (500,000)
Long-term portion, 12/31/05 P 500,000


[2] Non-interest-bearing Note, Net of Imputed Interest at 12/31/05
Face amount, 4/1/05 P 100,000
Less: imputed interest
[P100,000 (P100,0000 x 0.756)]

(24,400)
Balance, 4/1/05 P 75,600
Add: interest earned to 12/31/05
(P75,600 x 15% x 9/12)

8,505
Balance, 12/31/05 P 84,105

[3] Long-term Portion of Installment Contract Receivable at 12/31/05
Contract selling price, 7/1/05 P 200,000
Less: down payment, 7/1/05 (60,000)
Balance, 12/31/05 P 140,000
Less: installment due 7/1/06
[P50,000 (P140,000 x 16%)]

(27,600)
Long-term portion, 12/31/05 P 112,400

[4] Accrued Interest Note Receivable, Sale of Division, at 12/31/05
Interest accrued from 5/1 to 12/31/05
(P1,000,000 x 9% x 8/12)

P 60,000

[5] Accrued Interest Installment Contract at 12/31/05
Interest accrued from 7/1 to 12/31/05
(P140,000 x 16% x )

P 11,200

[6] Interest Income Note Receivable, Sale of Division, for 2005
Interest earned from 1/1 to 5/1/05
(P1,500,000 x 9% x 4/12)

P 45,000
Interest earned from 5/1 to 12/31/05
(P1,000,000 x 9% x 8/12)

60,000
Interest income P 105,000

[7] Interest Income Note Receivable, Officer, for 2005
Interest earned 1/1 to 12/31/05 (P400,000 x 8%) P 32,000

[8] Gain Recognized on Sale of Patent
Stated selling price P 100,000
Less: imputed interest (24,400) [2]
Actual selling price (P100,000 x 0.756) P 75,600
Less: cost of patent (net)
Carrying value 1/1/05 P40,000
Less amortization 1/1 to 4/1/06
(P8,000 x ) (2,000)

(38,000)
Gain recognized P 37,600

[9] Gain Recognized on Sale of Land
Sale of price P 200,000
Less: cost (150,000)
Gain recognized P 50,000

8-23. Grande Company

Requirement 1

PAS 39, paragraph 63 will be applied in this case. On December 31, 2006, Grande Company should record the 2006
accrued interest and the impairment:
Notes / Interest Receivable (0.06) (100,000) 6,000
Interest Income 6,000
Bad Debts Expense 55,537 *
Allowance for decline in note value 55,537
* Carrying value of note and interest (100,000 + 6,000) P106,000
Present value / New carrying value of
note (discount rate 6%)
Principal:
Due on 12.31.08 (P30,000 x 0.89000) P26,700
Due on 12.31.10 (P30,000 x 0.79209) 23,763 50,463
Impairment write-down P 55,537

Requirement 2
The entries with the corresponding computations follow:
Effective Interest Method
December 31, 2007
Interest income (0.06) (50,463) 3,028

December 31, 2008
Interest income
(0.06) (50,463 + 3,028) 3,209

Cash 30,000
Notes receivable 30,000

December 31, 2009
Interest income
(0.06) (50,463 + 3,208 + 3,209 30,000) 1,602


December 31, 2010

*

Interest income 1,698

*
0.06 (26,700 + 1,602)

Cash 30,000

To close remaining balance in
notes receivable and allowance

* At this point, the amortized cost of the notes receivable is zero.

Notes Receivable Allowance for Decline in Note Value
100,000 30,000 3,028 55,537
6,000 30,000 3,209
106,000 60,000 1,602
46,000 bal 1,698
9,537 55,537
46,000
8-24. Amy Corporation

Requirement 1

Accounts Receivable (Trade) 15,500
Accounts Receivable (Officer) 3,600
Ordinary Shares Subscriptions Receivable 12,000
Advances to Employees 1,800
Notes Receivable (Trade) 6,000
Deposit to Guarantee Contract Performance 5,000
Utility Deposit 500
Receivables 44,400

Requirement 2

Accounts receivable (trade)--current asset, trade receivable
Accounts receivable (officer)--normally current nontrade receivable
Ordinary shares subscription receivable--current or noncurrent asset, depending on due
date; nontrade receivable
Advances to employees--current asset, nontrade receivable
Notes receivable (trade)--noncurrent asset, trade receivable
Deposit to guarantee contract performance--separately classify, could be current or
noncurrent asset, depending on the length of the contract; nontrade receivable
Utility deposit--separately classify, probably noncurrent nontrade receivable
*
8-25. Janes Department Store

Requirement 1
Age Balance
Estimated
Percentage
Uncollectible
Estimated
Amount
Uncollectible
Under 30 days P193,000 0.008 P 1,544
30- 60 days 114,000 0.020 2,280
61-120 days 73,000 0.050 3,650
121-240 days 41,000 0.200 8,200
241-360 days 25,000 0.350 8,750
Over 360 days 19,000 0.600 11,400
P465,000 P35,824
Requirement 2

a. Bad Debt Expense 35,824

b. Bad Debt Expense (P35,824 + P3,000) 38,824

c. Bad Debt Expense (P35,824 P2,800) 33,024

8-26. Blue Corporation

Requirement 1
2005
Dec. 1 Cash [(P175,000 x 0.80) P1,400] 138,600
Assignment Service Charge Expense
(P175,000 x 0.80 x 0.01) 1,400
Notes Payable (P175,000 x 0.80) 140,000

Dec. 1 Accounts Receivable Assigned 175,000

11 Sales Returns and Allowances 1,000
Accounts Receivable Assigned 1,000

31 Cash 86,000

31 Notes Payable 86,000
Interest Expense (P140,000
x 0.12 x 1/12) 1,400
Cash 87,400

2006
Jan. 29 Cash 60,000

29 Notes Payable (P140,000 P86,000) 54,000
Interest Expense (P54,000
x 0.12 x 1/12) 540
Cash 54,540

29 Accounts Receivable 28,000
Accounts Receivable Assigned
(P175,000 P1,000
P86,000 P60,000) 28,000

Requirement 2
On the December 31, 2005 balance sheet of the Blue Corporation, the assigned accounts receivable and the
remaining liability would be reported as follows:
Current Assets:
Accounts receivable assigned P88,000
Current Liabilities:
Note payable P54,000

8-27. Tandy Shoes

Sept. 15 Accounts Receivable 1,995
Credit Card Expense (P2,100 x 0.05) 105
Sales 2,100

21 Sales Returns and Allowances 200
Credit Card Expense (P200 x 0.05) 10

29 Cash 1,805

8-28. Gabe Company

GABE COMPANY
Income Statement Effect

Expenses resulting from accounts receivable assigned
(Schedule 1)

P15,100
Expenses resulting from accounts receivable sold
(P300,000 P260,000)

40,000
Total expenses P55,100

Schedule 1: Computation of Expenses for Accounts Receivable Assigned
Assignment expense:

Accounts receivable assigned P200,000
x 85%
Advance by Belle P170,000
x 3%
P 5,100
Interest expense 10,000
Total expenses P 15,100

CHAPTER 9 SUBSTANTIVE TESTS OF INVENTORIES AND COST OF GOODS SOLD

9-1. Substantiation of the figure for inventories is an especially challenging task because of the variety of acceptable
methods of valuation. In addition, the variety of materials found in inventories calls for considerable experience and
skill to do an efficient job of identifying and test-counting goods on hand. The possibilities of obsolescence and of
excessive stocks also create problems. Finally, the relatively large size of inventories and their significance in the
determination of net income make purposeful misstatement by the client a possibility which the auditors must guard
against.

9-2. During an audit of a manufacturing company, the auditors review the cost system for the following purposes:
(1) To determine that costs are properly allocated to current and future periods and hence that cost figures used in
arriving at balance sheet and income statement amounts are supported by internal records.
(2) To obtain assurance that the cost system, as an integral part of the system of internal control, provides proper
accounting control over costs incurred and related inventories.
(3) To ascertain, as a service to management, that the cost system is economical and effectively provides information
for reducing or controlling costs and for determining the cost and profitability of products, and other related data
necessary for informed managerial decisions.

9-3. The auditors make test counts of inventory quantities during their observation of the taking of the physical inventory to
ascertain that an accurate count is being made by the individuals taking the inventory. The extent of test counting will
be determined by the inventory-taking procedures; for example, the number of the auditors test counts would be
reduced if there were two teams, one verifying the other, taking the inventory. On the other hand, the auditors test
counts would be expended if they found errors in the inventory counts.

9-4. The statement is not true. The auditors responsibilities with respect to inventories include not only quantities and
pricing, but also the quality or condition of the goods, the accuracy of extensions, footing, and summaries, and the
evaluation of internal control. Weakness in internal control may cause large losses from excessive stockpiling,
obsolescence, inaccurate cost data, and many other sources, even though the ending inventory is properly counted and
priced.

9-5. The independent auditors utilize the clients backlog of unfilled sales orders in the determination of net realizable value
of finished goods and goods-in-process, and in the determination of losses, if any, on firm sales commitments for which
no production has yet been undertaken.

9-6. Beed Company

Since Beed Company obtained all of its merchandise inventory from the president of the company in a related-party
transaction, the auditors must determine the cost of the merchandise to the president in his operation of a similar
business as a single proprietor. In this related-party transaction, the auditors must look beyond form--a total cost of
P100,000 for the original stock of merchandise--to substance. Substantively, the merchandise of Beed Company
should be priced, on a specific identification basis if feasible, at its cost from the suppliers of the sole proprietorship.
Any difference between cost as thus determined and amounts charged by the president to Beed Company represents
unamortized discount on the notes payable. The entire transaction should be fully disclosed in a note to the financial
statements of Beed Company.


9-7. J ay Company

The following procedures should be undertaken:
(a) The oral evidence that the motors are on consignment should be substantiated by a review of the clients records
of consigned inventory, examination of contracts and correspondence with consignors, and confirmation of
consigned stocks by direct communication with consignors.
(b) The location of the machine in the receiving department, together with the presence of the REWORK tag,
suggests that the machine had been shipped to a customer but rejected and returned by the customer. The
auditors should examine the receiving report for the machine, the accounts receivable confirmation from the
customer, and records of the clients quality control department, to ascertain who has title to the machine. If the
customer has title, the machine should not be included in inventory, and a liability for rework costs should be
established. If the client has title, the customers account should be credited for the sales return and the machine
should be included in the clients inventory at estimated realizable value.
(c) The Material Inspection and Receiving Report signed by the Navy Source Inspector, is evidence that title to the
machine passed to the Phil. Naval Base on November 30, 2006. Accordingly, the auditors should ascertain that
the sales value of the machine is included in accounts receivable, and that the cost of the machine is not in the
perpetual inventory or the physical inventory.
(d) The location of the storeroom and the dusty condition of the goods suggest that the items may be obsolete, or at
least slow moving. The auditors should inspect perpetual inventory records for usage of the materials, and
should inquire of production personnel whether the materials are currently useful in production. The materials
may have to be valued at scrap value.

9-8. Pancho Manufacturing Corporation

(a) Consignment out.
1. Obtain from the client a complete list of all consignees together with copies of the consignment contracts.
2. Evaluate the consignment contract provisions relative to the following areas:
(a) Payment of freight and other handling charges.
(b) Extension of credit.
(c) Rates and computation of commissions to consignees.
(d) Frequency and contents of reports and remittances received from consignees.
3. Discuss with the client any variations found in the contracts which do not seem justified by the
circumstances.
4. Following review of the consignment contracts, communicate directly with the consignees to obtain complete
information in writing on merchandise remaining unsold, receivables resulting from sales, unremitted
proceeds, and accrued expenses and commissions, which should be reconciled with the clients records for
the period covered by the engagement.
5. Determine that merchandise on consignment with consignees is valued on the same basis as merchandise on
hand, and included as part of the inventory. Ascertain that any arbitrary mark-ons are deducted and that
shipping and related charges for the transfer of merchandise to the consignees are reflected as part of the
inventory.
6. Ascertain that quantities of goods in hands of consignees at the close of the period under audit appear in the
balance sheet and are separately designated as Merchandise on Consignment.

(b) Finished merchandise in public warehouse pledged as collateral for outstanding debt.
1. Determine that goods pledged to obtain funds are covered by warehouse receipts. (The examination of
warehouse receipts alone is not a sufficient verification of goods stored in public warehouses.)
2. Request direct confirmation from the warehouses in which the merchandise is held.
3. If available, obtain independent accountants reports on a warehouses internal controls over custody of stored goods.
4. Review the clients procedures for acceptance and evaluation of the performance of warehouses, and review
supporting documents.
5. Review the loan agreements collateralized by warehouse receipts. These agreements usually provide for
certain payments to be made by the borrower as pledged goods are sold.
6. Consider observing a physical inventory of goods stored at the public warehouses.

9-9. a. (2) b. (3) c. (2) d. (2) e. (4) f. (2)

9-10. a. Principal problems the auditor will face are related by:
1. Verification of existence of the inventory owned by the company as against inventory belonging to the
customers.
2. Proper valuation since the perpetual inventory records reflect quantities only.

b. Steps that should be undertaken to enable the auditor to render an unqualified opinion:
1. Verify postings to the perpetual ledger at the plant office for both stock owned and stock being held for
customers against original cost sheet to determine amounts debited and credited to the account.
2. Require that an annual physical inventory taking be done by the client and arrangements for the presence and
observation of the auditor be done.
3. Confirm with customers unclaimed merchandise still in the possession of the client as of the balance sheet
date.

9-11. 1. Existence or occurrence
2. Existence or occurrence
3. Valuation or allocation
4. Completeness
5. Completeness
6. Valuation or allocation
7. Completeness
8. Completeness
9. Existence or occurrence and completeness
10. Completeness

9-12. a. When the inventory is a material item in the financial statements that the auditor is examining, observation of the
taking of the physical inventory is in compliance with the auditing standard pertaining to field work that requires
obtaining sufficient competent evidential matter to afford a reasonable basis for an opinion regarding the financial
statements. Observation is a generally accepting auditing procedure applied in the examination of the physical
inventory.

By observing the taking of the physical inventory, the CPA is seeking to satisfy himself or herself as to the
effectiveness of the methods of inventory taking and the measure of reliance that can be placed on the client
inventory records and their representations as to inventory quantities. The CPA must ascertain that the physical
inventory actually exists, that the inventory quantities are being determined by reasonably accurate methods, and
that the inventory is in a salable or usable condition.

b. The CPA makes test counts of inventory quantities during observation of the taking of the physical inventory to
become satisfied that an accurate count is being made by the individuals taking the inventory. The extent of test
counting will be determined by the inventory-taking procedures. For example, the number of test counts would be
reduced if there were two teams taking the inventory, one checking the other. On the other hand, the CPAs test
count would be expanded if errors were found in the inventory counts.

Some test counts are recorded by the CPA for the purpose of subsequent comparison with the clients compilation
of the inventory. The comparison procedure goes beyond the mere determination that quantities have been
accurately transcribed. In addition, the CPA seeks assurance that the description and condition of the inventory
items are accurate for pricing purposes and that the quantity information, such as dozen, gross, and cartons, is
proper.

c. 1. The CPA does not regard the inventory certificate of an outside service company as a satisfactory substitute for his
or her own audit of the inventory. The service company has merely assumed the clients function of taking
the physical inventory, pricing it, and making the necessary extensions. To the extent that the service
company is competent, internal control with regard to the inventory has been strengthened. Nevertheless, as
under other strong systems of internal control, the CPA would investigate the system to become satisfied that
it is operating in a satisfactory manner. The CPAs investigation would necessarily entail an observation of
the taking of the inventory and testing the pricing and calculation of the inventory.

2. The inventory certificate of the outside specialists would have no effect on the CPAs report. The CPA must be
satisfied that the inventory is fairly stated by observing the taking of the inventory and by testing the pricing
and calculation of the inventory.

However, if the taking of the inventory was not observed and no audit tests were applied to the computation
of the inventory, the CPA would be compelled to disclaim an opinion on the financial statements as a whole
if the amount of the inventory is material.

If it has been impracticable or impossible for the CPA to observe the taking of the physical inventory but he
or she has been satisfied by the application of other auditing procedures, the CPA would make no reference
to the matter in the report.

3. The CPA would make no reference to the certificate of the outside specialists in the report. The outside specialists
are serving as adjuncts of the companys staff of permanent employees and, as such, are in somewhat the
same position as temporary employees. The outside specialists are not independent in that they are not
imbued with third-party interests. The CPA is compelled, under certain circumstances, to mention in the
report the reports of other independent auditors, but this compulsion does not extend to the certificate of
outside specialists who are not independent auditors.

9-13. a. For a client to dispose of the chemical compound in a manner that meets legal requirements is admirable.
However, ethical behavior frequently calls for individual persons and companies to exhibit behavior that exceeds
the minimum standards set by law. Due to the harm to cattle and the pollution that has resulted. Remote is
involved in a matter that entails ethical issues.

b. Most auditors are hesitant to serve as judge and jury for clients on ethical matters. For example, declining to serve
this client probably would not cause any alteration of its behavior. Further, serving the client does not facilitate
any unethical behavior. Further, serving the client does not facilitate any unethical behavior. Hence, an auditor
might choose to discuss the matter with the board and encourage them to act as responsible citizens.

9-14. J C

Requirement (1)

Inventory, as given ................................................................... P271,500
Deduct (adjustments to cost):
50% markup in (a) [P250,000 (P250,000 1.5)] .......... P83,333
60% markup in (b) (P10,000 x 0.60) ................................ 6,000
Exclusion of (c) ................................................................ 4,000
Incorrect amount used in (e) (P2,500 P1,000) ............... 1,500 94,833
P176,667
Add:
Freight on goods in transit in (d) ...................................... 800
Corrected ending inventory .............................................. P177,467

Requirement (2)

Income Statement
a. Ending inventory overstated (P250,000 P177,467) ...................... P72,533
b. Cost of goods sold understated ........................................................ 72,533
c. Gross margin overstated .................................................................. 72,533
d. Pretax income overstated ................................................................. 72,533
e. Income taxes overstated (P72,533 x 0.40) ....................................... 29,013
f. Net income overstated (P72,533 P29,013) ................................... 43,520

Balance Sheet:
Current assets, inventory overstated ...................................................... 72,533
Current liabilities, income taxes payable overstated .............................. 29,013
Retained earnings overstated ................................................................. 43,520

Requirement (3)

Retained earnings (prior period adjustment) ............................ 43,520
Income taxes payable ............................................................... 29,013
Inventory .......................................................................... 72,533

9-15. Beginning inventory P 38,000
Purchases 19,000
Cost of goods available for sale P 57,000
Cost of goods sold (net sales of P51,000 1.50) 34,000
Ending inventory before theft P 23,000
Ending inventory after theft 15,000
Inventory lost P 8,000

9-16. LRT Company
LRT COMPANY
Computation of Value of Inventory Lost
February 16, 2006
Sales P 40,000
Less: Gross profit (40%) 16,000
Cost of goods sold P 24,000
Finished goods, February 16 75,000
Cost of goods available for sale P 99,000
Less: Finished goods, December 31, 2005 72,000
Cost of goods manufactured and completed P 27,000

Raw materials, December 31, 2005 P 65,000
Raw materials purchases 20,000
Raw materials available for production P 85,000
Raw materials before flood 70,000 (P35,000 1/2)
Raw materials used P 15,000
Direct labor 30,000
Manufacturing overhead cost 15,000
Goods in process, December 31, 2005 80,000
Cost of production P 140,000
Less: Cost of goods completed (from above) 27,000
Goods in process inventory lost in flood P 113,000

Total value of inventory = Raw materials lost + Goods in process lost destroyed by flood
= (P70,000 - P35,000) + P113,000
= P148,000
9-17. Y Company

a. Necessary adjustments to clients physical inventory:

Material in Car #AR38162--received in
warehouse on January 2, 2007 P 8,120
Materials stranded en route
(Sales price P19,270/125%) 15,416
Total 23,536
Less unsalable inventory 1,250*
Total adjustment P22,286

* If freight charges have been included in the clients inventory, the amount would be P1,600 and the amount
of the total adjustment would be P21,936. Journal entry 6 probably would have a credit to purchases of
P1,600 in this case.
b. Auditors worksheet adjusting entries:
1. Purchases P 2,183
Accounts Payable P 2,183
To record goods in warehouse but not
invoiced-received on RR 1060.
2. No entry required. Title to goods had passed.
3. Accounts receivable 12,700
Sales 12,700
To record goods as sold which were
loaded on December 31 and not
inventories-SI 968.
4. Sales 19,270
To reverse out of sales material included
in both sales (SI 966) and in physical
inventory (after adjustment).
5. No adjustment required.
6. Claims receivable 1,600
Purchases 1,250
Freight In 350
To record claim against carrier for
merchandise damaged in transit.
7. Inventory 22,286
Cost of goods sold 22,286
To adjust accounts for changes in physical
inventory quantities.
8. Sales 15,773
To reverse out of sales invoices #969, #970,
#971. The sales book was held open too long.
This merchandise was in warehouse at time
of physical count and so included therein.

9-18. Engine Warehouse Supply Company

a. Cutoff errors will exist for accounts payable whenever the liability for a purchase is recorded in the wrong period.
The following rules should be followed for recording purchases:
1. Record as of date received when shipped FOB destination.
2. Record as of date shipped when shipped FOB origin.

On this basis, the receiving reports would be evaluated as follows:

Receiving
Report
No.

Amount

Date
Shipped

Date
Received

FOB Point
Should be
Recorded in
August
Was Recorded
in August
679 P 860 8-29 8-31 Destination Yes Yes
680 1,211 8-27 9-01 Origin Yes Yes
681 193 8-20 9-01 Origin Yes Yes
682 4,674 8-27 9-01 Destination No Yes
683 450 8-30 9-02 Destination No No
684 106 8-30 9-02 Origin Yes No
685 2,800 9-06 9-02 Origin No No
686 686 8-30 9-02 Destination No No

The entry to adjust the records as of August 31 for cutoff errors in accounts payable is as follows:

Dr. Accounts payable P4,568
Cr. Purchases P4,568

To adjust accounts payable for cutoff errors in recording inventory purchases:

RR No. 682 P4,674
RR No. 684 ( 106)
P4,568

b. Sales should be recorded as of the date shipped. The following shipping documents were dated on September 1
and recorded in August:

311 P 56
312 3,194
313 635
314 193
P4,078

The adjusting entry will be:

Dr. Sales P4,078
Cr. Accounts receivable P4,078
To adjust sales for cutoff errors at August 31.

c. 1. Inventory received near the balance sheet date should be included in inventory if it is recorded as a purchase
and excluded if it is not recorded as a purchase.
2. Inventory shipped near the balance sheet date should be excluded from inventory if it is recorded as a sale
and included if it has not been recorded as a sale.

These principles lead to the following analysis.

Receipt of Goods
1. Inventory for all receiving reports up to 684 are included in inventory.
2. Using the analysis in part a, column 6, inventory for all receiving reports up to 684, except 682 and 683,
should be included in accounts payable and inventory.


Report No.

Amount
Should be Included in Purchases
and Inventory
Was Included
in Inventory
679 860 Yes Yes
680 1,211 Yes Yes
681 193 Yes Yes
682* 4,674 No Yes
683* 450 No Yes
684 106 Yes Yes
685 2,800 No No
686 686 No No

* Requires removal from inventory.

3. Inventory for receiving reports 682 and 683 should therefore be removed from the physical count:
Amount
682 4,674
683 450
5,124

Shipment of Goods
1. Inventory for shipping documents 314 to 317 were included in inventory. All inventory for documents 313
and earlier were excluded.
2. Sales, after adjustments, were included only for shipments 310 and those preceding, as shown in the analysis
in part b.
3. Inventory for shipping documents 311 to 313 should therefore be added to inventory. The amount of the cost
of the inventory cannot be determined without reference to inventory costs. Presumably, cost will be less
than the sales value shown in part b.

Shipping
Document No.
Included in
Physical
Recorded as Sale After Adjustments in
Part b
310 No Yes
311* No No
312* No No
313* No No
314 Yes No
315 Yes No
316 Yes No
317 Yes No
318 Yes No
* Requires addition to inventory at cost.

Shipping
Document No.
Selling
Price
311 P 56
312 3,194
313 635
Inventory cost 3,885
(70% of selling price) 2,719

Summary
Reduction of inventory due to physical count error
resulting from receipt of goods. P5,124.00
Increase of inventory due to physical count error
resulting from shipment of goods. 2,719.50
Net reduction of inventory required P2,404.50

d. The accuracy about September 1 receipts and shipments of goods could be verified by reference to bills of lading.

9-19. Green Company

Requirement (a)
Green Company
Inventory
12.31.06

Per Audit
Item Quantity Unit Price * Amount Per Client
A 510 720 units P 2.64 / doz. P 218.40 P 2,592.00
A 520 48 units 4.70 each 225.60 252.60
A 530 146 units 16.50 each 2,409.00 2,706.00
A 540 86 units 5.15 each 442.90 353.60
A 550 80 units 8.50 each 680.00 7,280.00
A 560 140 units 2.00 each 3,360.00 280.00
A 570 910 gross 132 gross 120,120.00 27,360.00
Total P127,455.90 P 40,824.20
Add: AJE (1) __________ 86,631.70

P127,455.90 P127,455.90

* Lower of cost or market

Requirement (b)

Inventory 86,631.70
Cost of sales 86,631.70

9-20.
Requirement (a) Requirement (b)
1. Exclude Title to the goods passed to the client on January 3, 2007 or
upon receipt because the term of shipment was FOB
Destination.
2. Exclude Goods held on consignment are not owned by the client.
3. Include Regular stock item even if segregated but not actually delivered
as of the end of the year is still part of the clients inventory.
4. Include Title to the goods passed to the client on December 31, 2006 or
upon shipment because the invoice showed FOB suppliers
warehouse.
5. Exclude Goods fabricated to order for a customer are considered sold as
soon as completed even if not yet delivered.

9-21. I sabela Company

ISABELA COMPANY
Worksheet to Correct Selected Accounts
12-31-06

Inventory Accounts Payable Sales
Initial amounts P1,250,000 P1,000,000 P9,000,000
Adjustments
Increase (Decrease)
1 P (155,000) P (155,000) None
2 (22,000) None None
3 None None P 40,000
4 210,000 None None
5 25,000 25,000 None
6 2,000 2,000 None
7 (5,300) (5,300)
None
Total adjustments P 54,700 P (133,300) P 40,000
Adjustment amounts P1,304,700 P 866,700 P9,040,000

9-22. Stockroom W

Stockroom W
Reconciliation of Inventory

Opening
Inventory

Receipts

Withdrawals
Ending
Inventory
Balance per Accounting Department P 22,600 P28,000 P 26,000 P 24,600
Add (Deduct) Reconciling Items
1) Receipt of materials erroneously posted by
the Accounting Department to Stockroom W.

480

480
2) Correction of error in the Accounting
Department.

( 600)

( 600)

3) Shortage not recorded in the Accounting
Department.

_______

______

90

(90)
Balance per Factory Records P 22,000 P28,480 P 25,490 P 24,990

9-23. Pinas Company

Requirement (1)

Audit Adjustments, 12.31.06

1. Retained earnings 300
Purchases 300
2. Inventory, January 1, 2006 700
Retained earnings 700
3. Accounts receivable 500
Sales 500
4. Purchases 500
Accounts payable 500
5. Inventory, Dec. 31, 2006 B/S 400
Inventory, Dec. 31, 2006 I/S 400
6. a. Purchases 1,200
Accounts payable 1,200
b. Inventory, Dec. 31, 2006 B/S 1,200
Inventory, Dec. 31, 2006 I/S 1,200
7. Accounts payable 800
Purchases 800

Requirement (2)

Pinas Company
Cost of Sales
2006

Per Adjustments Per
Client Dr
Cr
Audit
Inventory, Jan. 1 P 3,200 P 700 (2) P 3,900
Purchases 21,100 500 (4) P 300 (1)
_______ 1,200 (6a) 800 (7) 21,700
Total available 24,300 25,600
Less: Inventory, Dec. 31 4,300 400 (5)
_______ ______ 1,200 (6b) 5,900
Cost of sales P 20,000 P 2,400 P 2,700 P19,700

9-46 Solutions Manual to Accompany Applied Auditing, 2006 Edition

* Credits.
Retained Earnings is negative after correction.

9-24. Bers Company

Uncorrected

Items for Correction

Corrected
Amounts (a) (b) (c) (d) (e) Amounts
Income statement:
Sales revenue .................................. P90,000 12,000 15,000 P 63,000
Cost of goods sold ........................... 50,000 + 6,000 + 15,000 8,000 63,000
Gross margin ................................... 40,000 0
Expenses ......................................... 30,000 + 7,000 37,000
Income ............................................ P10,000 7,000 12,000 6,000 15,000 7,000 P(37,000)
Balance sheet:
Accounts receivable ........................ P42,000 12,000 15,000 P15,000
Inventory ......................................... 20,000 15,000 + 8,000 13,000
Remaining assets ............................. 30,000 30,000
Accounts payable ............................ 11,000 * + 6,000 17,000 *
Remaining liabilities ....................... 6,000 * + 7,000 13,000 *
Share capital, ordinary .................... 60,000 * 60,000 *
Retained earnings
......................... 15,000 * 7,000 12,000 6,000 15,000 7,000 (32,000)

Totals .......................................... P 0 P 0
9-1 Solutions Manual to Accompany Applied Auditing, 2006 Edition
9-25. 1. Jap Co.
P150,000 (P150,000 X .20) = P120,000;
P120,000 (P120,000 X .10) = P108,000, cost of goods purchased

2. Fred Company
P1,100,000 + P69,000 = P1,169,000. The P69,000 of goods in transit on which title had passed on December 24
(f.o.b. shipping point) should be added to 12/31/06 inventory. The P29,000 of goods shipped (f.o.b. shipping
point) on January 3, 2007, should remain part of the 12/31/06 inventory.

3. B. May Corp.
Because no date was associated with the units issued or sold, the periodic (rather than perpetual) inventory method
must be assumed.

FIFO inventory cost: 1,000 units at P24 P 24,000
1,100 units at 23 25,300
Total P 49,300

Average cost: 1,500 at P21 P 31,500
2,000 at 22 44,000
3,500 at 23 80,500
1,000 at 24 24,000
Totals 8,000 P180,000

P180,000 8,000 = P22.50

Ending inventory (2,100 X P22.50) is P47,250.

4. Emmett Lopez Inc.
The inventoriable costs for 2007 are:

Merchandise purchased P909,400
Add: Freight-in 22,000
931,400
Deduct: Purchase returns P16,500
Purchase discounts 6,800 23,300
Inventoriable cost P908,100
9-26.

(a) (1) 8/10
Purchases 9,000

8/13
Purchase Returns and Allowances 1,200

8/15
Purchases 12,000

Substantive Tests of Cash 7-2

8/25
Purchases 15,000

8/28
Cash 12,000

(2) Purchasesaddition in cost of goods sold section of income statement.
Purchase returns and allowancesdeduction from purchases in cost of goods sold section of
the income statement.
Accounts payablecurrent liability in the current liabilities section of the balance sheet.

(b) (1) 8/10
Purchases 8,820
Accounts Payable (P9,000 X .98) 8,820

8/13
Purchase Returns and Allowances 1,176
(P1,200 X .98)

8/15
Purchases 11,880

8/25
Purchases 14,700
8/28
Purchase Discounts Lost 120
Cash 12,000

(2) 8/31
Purchase Discounts Lost 156
Accounts Payable
(.02 X [P9,000 P1,200])

156

(3) Same as part (a) (2) except:

Purchase Discounts Losttreat as financial expense in income statement.

(c) The second method is better theoretically because it results in the inventory being carried net of purchase
discounts, and purchase discounts not taken are shown as an expense. The first method is normally used,
however, for practical reasons.

9-27. MAR Company

(a) Purchases
Total Units
Sales
Total Units
April 1 (balance on hand) 100 April 5 300
April 4 400 April 12 200
April 26 500 Total units 1,400
April 30 200
Total units 1,700
Total units sold 1,400
Total units (ending inventory) 300

Assuming costs are not computed for each withdrawal:
(1) First-in, first-out.

Date of Invoice No. Units Unit Cost Total Cost
April 30 200 P5.80 P1,160
April 26 100 5.60 560
P1,720
(2) Average cost.

Cost of Part X available.

Date of Invoice No. Units Unit Cost Total Cost
April 1 100 P5.00 P 500
April 4 400 5.10 2,040
April 11 300 5.30 1,590
April 18 200 5.35 1,070
April 26 500 5.60 2,800
April 30 200 5.80 1,160
Total Available 1,700 P9,160

Average cost per unit = P9,160 1,700 = P5.39.
Inventory, April 30 = 300 X P5.39 = P1,617.

(b) Assuming costs are computed for each withdrawal:

(1) First-in, first out.

The inventory would be the same in amount as in part (a), P1,720.

(2) Average cost.

Purchased Sold Balance

Date
No. of units Unit cost No. of
units
Unit cost No. of
units
Unit cost*
Amount
April 1 100 P5.00 100 P5.0000 P 500.00
April 4 400 5.10 500 5.0800 2,540.00
April 5 300 P5.0800 200 5.0800 1,016.00
April 11 300 5.30 500 5.2120 2,606.00
April 12 200 5.2120 300 5.2120 1,563.60
April 18 200 5.35 500 5.2672 2,633.60
April 26 500 5.60 1,000 5.4336 5,433.60
April 27 800 5.4336 200 5.4336 1,086.72
April 28 100 5.4336 100 5.4336 543.36
April 30 200 5.80 300 5.6779 1,703.36

Inventory April 30 is P1,703.
*Four decimal places are used to minimize rounding errors.
9-28. Timmy Turner

Requirement (a)
Merchandise on hand, January 1 P38,000
Purchases P72,000
Less purchase returns and allowances 2,400
Net purchases 69,600
Freight-in 3,400 73,000
Total merchandise available for sale 111,000
Cost of goods sold* 75,000
Ending inventory 36,000
Less undamaged goods 10,900
Estimated fire loss P 25,100

*Gross profit =
33 1/3%
= 25% of sales.
100% + 33 1/3%
Cost of goods sold = 75% of sales of P100,000 = P75,000.

Requirement (b)
Cost of goods sold = 66 2/3% of sales of P100,000 = P66,667
Ending inventory [P111,000 (as computed above)
P66,667]

P44,333
Less undamaged goods 10,900
Estimated fire loss P33,433

9-29. Cosmo and Wanda Company

Beginning inventory P170,000
Purchases 390,000
560,000
Purchase returns (30,000)
Total goods available 530,000
Sales P650,000
Sales returns (24,000)
Net sales 626,000
Less gross profit (40% X P626,000) (250,400) 375,600
Estimated ending inventory (unadjusted for
damage)

154,400
Less goods on handundamaged (at cost)
P21,000 X (1 40%)

(12,600)
Less goods on handdamaged (at net
realizable value)

(5,300)
Fire loss on inventory P136,500


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CHATER 7 SUBSTANTIVE TESTS OF CASH

Retained Earnings is negative after correction.

......................... 15,000 * 7,000 12,000 6,000 15,000 7,000 (32,000)

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