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UNIT 7

AUDIT OF PROPERTY, PLANT AND EQUIPMENT


AND RELATED VALUATION ACCOUNTS
Estimated Time: 4.5 HOURS

Discussion questions 7-1


1. Define the following terms. You should provide an example of each.
a. Qualifying assets
b. Borrowing costs
c. Revaluation
d. Impairment
2. You are making your first audit of Sigma Manufacturing Company. The Plant and
Equipment account represents a very substantial portion of the total assets. What
verification, if any, will you make of the balances of the ledger accounts for Plant and
Equipment as of the beginning of the period under audit?
3. Prepare an audit program for the property, plant and equipment. Explain.
Problem 7-1 Capitalizable Cost
The property, plant and equipment section of ABC Corporations statement of financial
position at December 31, 2015 included the following items:
Land
Land Improvements
Building
Machinery and equipment

P2,500,000
560,000
3,600,000
6,600,000

During 2016 the following data were available to you upon your analysis of the accounts:
Cash paid on purchase of land
P10,000,000
Mortgage assumed on the land bought, including interest at 16%
16,000,000
Realtors commission
1,200,000
Legal fees, realty taxes and documentation expenses
200,000
Amount paid to relocate persons squatting on the property
400,000
Cost of tearing down an old building on the land
300,000
Amount recovered from the salvage of the building demolished
600,000
Cost of fencing the property
440,000
Amount paid to a contractor for the building erected
8,000,000
Building permit fees
50,000
Excavation expenses
250,000
Architects fee
100,000
Interest that would have been earned had the money used during
the period of construction been invested in the money market
600,000
Invoice cost of machinery acquired
8,000,000
Freight, unloading and delivery charges
240,000
Customs duties and other charges
560,000
Allowances, hotel accommodations, etc. paid to foreign
technicians during installation and test run of machines
1,600,000
Royalty payments on machines purchased (based on units
produced and sold)
480,000

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Required: Based on the above and the result of your audit, compute for the following as
of December 31, 2016:
1. Land
2. Land Improvements
3. Building
4. Machinery and Equipment
5. Total depreciable property, plant and equipment
Problem 7-2 (Acquisition of PPE, Exchange and Government Grants)
The following were discovered during your audit of DEF Companys financial statements
for the year ended December 31, 2016:
1. (Cash Acquisition) On December 24, 2016, DEF purchased an office equipment for
P400,000, terms 2/5, n/15. No entry was made on the date of purchase. The same
was paid on December 31, 2016 and the accountant debited Office Equipment and
credited cash for P400,000.
2. (Installment Acquisition) Machine C, with a cash price of P128,000, was purchased
on January 2, 2016. The company paid P20,000 down and P10,000 for 12 months.
The last payment was made on December 30, 2016. Straight line depreciation,
based on a five-year useful life and no salvage value, was recorded at P28,000 for
the year. Freight of P4,000 on machine C was debited to the Freight in account.
3. (Acquisition through Issuance of Bonds Payable) Machine P with a cash selling price
of P360,000 was acquired on April 1, 2016, in exchange for P400,000 face amount of
bonds payable selling at 94, and maturing on April 1, 2026. The accountant recorded
the acquisition by a debit to Machinery and a credit to Bonds Payable for P400,000.
Straight line depreciation was recorded based on a five-year economic life and
amounted to P54,000 for nine months. In the computation of depreciation, residual
value of P40,000 was used. The effective interest rate is 1.06%.
4. (Non-cash Acquisitions) Machine A was acquired on January 22, 2016, in exchange
for past due accounts receivable of P140,000, on which an allowance of 20% was
established at the end of 2015. The current fair value of the machine on January 22
was estimated at P110,000. The machine was recorded by a debit to Machinery and
a credit to Accounts Receivable for P140,000. No depreciation was recorded on
Machine A, because it was not installed and never used in operations. On February
2, 2016, Machine A was exchanged for 1,000 shares of the companys outstanding
capital stock with market price of P105 per share. The Treasury Stock account was
debited for P140,000 with the corresponding credit to Machinery.
5. (Exchange: With Commercial Substance) On December 29, 2016, DEF Company
exchanged 10,000 shares of Eric, Inc. common stock, which the Company was
holding as an investment, for an equipment from Magcale Corporation. The common
stock of Eric, Inc., which had been purchased by DEF for P45 per share, had a
quoted market value of P50 per share on the date of exchange. The equipment had a
market value of P470,000. The transaction was recorded by a debit to Equipment
and a credit to Investment in Eric, Inc.-Common for P450,000. The exchange was
assumed to be with commercial substance.
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6. (Exchange: No Commercial Substance) On December 30, 2016, Machine M with a


carrying amount of P120,000 (cost P400,000) was exchanged for a similar asset with
a fair value of P150,000. In addition, DEF paid P20,000 to acquire the new machine.
The exchange, which lacks commercial substance, was recorded by a debit to
Machinery and a credit to cash for P20,000.
7. (Trade-in) Machine E was recorded at P102,000, which included the carrying amount
of P22,000 for an old machine accepted as a trade in, and cash of P80,000. The
cash price of Machine E was P90,000, and the trade in allowance was P10,000. This
transaction took place on December 31, 2016.
8. (Donation of PPE by a Shareholder) Ms. Beauty, the companys president, donated
land and building appraised at P200,000 and P400,000, respectively, to the company
to be used as plant site. The company began operating the plant on September 30,
2016. The building is estimated to have a useful life of 25 years. Since no money was
involved, no journal entry was made for the above transaction.
9. (Government Grants: Land) On July 1, 2015, the national government granted a
parcel of land located in Scarborough Shoal, Zambales to DEF. On the date of grant,
the land had a fair value of P2,000,000. The grant required DEF to construct a cold
storage building on the site. DEF finished the construction of the building, which has
an estimated useful life of 25 years, on January 2, 2016. DEF appropriately recorded
the cost of the building of P4,000,000 (which include direct materials, direct labor,
and indirect cost and incremental overhead) but failed to provide depreciation in
2016. Unaware of the accounting procedures for government grants, the company
did not reflect the grant on its books.
10. (Government Grants: Depreciable Assets) On January 1, 2016, the national
government granted a building located in Scarborough Shoal, Zambales to DEF. On
the date of grant, the building had a fair value of P10,000,000. The grant required
DEF to establish a security camp to guard the disputed site. The building has an
estimated useful life of 20 years. Unaware of the accounting procedures for
government grants, the company did not reflect the grant on its books.

Required: As DEFs external auditor, you are required to prepare any necessary
adjusting journal entries as of December 31, 2016.
Problem 7-3 Cost of Land and Building
The Blue Corporation was incorporated on January 2, 2016, but was unable to begin
manufacturing activities until July 1, 2016 because the new factory facilities were not
completed until that date.
The Land and Building account at December 31, 2016 follows:
Date
Particulars
Jan. 31
Land and building
Feb. 28
Cost of removal of old building
May 2
Partial payment on new construction
May 2
Legal fees paid
Jun. 1
Second payment on new construction
Jul. 1
Claims for damages sustained during the construction of
building
Auditing Practice I
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Amount
P1,098,000
60,000
700,000
15,000
600,000
26,000

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Jul. 1
Dec. 31

Final payment on new construction


Asset revaluation surplus

Dec. 31

Depreciation 2016 at 1% of account balance

200,000
500,000
P3,199,000
31,990
P3,167,010

You were able to gather the following during your audit:


A. To acquire land and building, the company paid P98,000 cash and 10,000 shares
of its 9% cumulative preferred shares, P100 par value per share. The shares
were then selling at P120.
B. Legal fees covered the following:
Cost of incorporation
P9,500
Examination of title covering purchase of land
4,000
Legal work in connection with construction contract
1,500
Total
P15,000
C. Because of a general increase in construction materials costs after entering into
the building contract, the board of directors increased the value of the building by
P500,000, believing such increase is justified to reflect current market value at
the time the building was completed. Retained earnings was credited for this
amount.
D. Estimated useful life of the building is 25 years.
E. The Company opted to follow the cost model as its accounting policy.

Required:
1. Prepare the necessary adjusting journal entries as of December 31, 2016.
2. Determine the adjusted balances of the following as of December 31, 2016:
a. Land
b. Carrying value of building
c. Land and building
d. Organization cost, net (presented under Noncurrent Assets)
Problem 7-4 Valuation of Property, Plant and Equipment
At the beginning of the year, Judith Companys noncurrent assets and accumulated
depreciation accounts had the following balances:
Cost
Land
Buildings
Machinery and Equipment
Delivery Equipment
Leasehold improvements

P 130,000
1,200,000
775,000
132,000
230,000

The companys policy regarding depreciation is:


Depreciation Method
Land Improvements
Straight-line
Buildings
150% declining balance
Machinery and Equipment
Straight-line
Delivery Equipment
150% declining balance
Leasehold improvements
Straight-line

Accumulated
Depreciation
P 263,101
200,000
86,724
115,000
Useful Life
15 years
25 years
10 years
5 years
8 years

Depreciation is to be computed to the nearest month.


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Transactions for the current year are as follows:


Jan. 6

A plant consisting of land and building was acquired from Salome


Company for P600,000. 80% of the selling price was allocated to the
building.

April 6

New parking spaces were completed for the new plant at a total cost of
P240,000.

April 29

Judith exercised the renewal option to extend the lease agreement for an
additional 4 years.

July 1

Machinery and equipment were purchased at a total invoice price of


P250,000 Delivery and installation costs of P10,000 and P30,000 were
also incurred respectively.

Aug. 30

A new delivery equipment was purchased for P15,000.

Sept. 30

A delivery equipment with a cost of P24,000 and a carrying amount of


P9,114 on the date of sale was sold for P12,000. Depreciation for the 9
months ended September 30, 2016 was P2,646.

Dec. 20

A machine with a cost of P20,000 and a carrying amount of 5,000 at date


of disposition was scrapped.

Additional information:
The leasehold improvements were completed on December 31, 2012. The related lease
was to be terminated on December 31, 2018.

1.
2.
3.
4.
5.
6.
7.
8.

How much is the depreciation expense on land improvements for 2016?


How much is the depreciation expense on building for 2016?
How much is the depreciation expense on machinery and equipment for 2016?
How much is the carrying value on January 1 of the delivery equipment sold on
September 30?
How much is the depreciation expense for 2016 on delivery equipment?
How much is the depreciation expense on leasehold improvements for 2016?
How much is the total depreciation expense for 2016?
How much is the book value of the machinery and equipment on December 31,
2016?

Problem 7-5 Valuation of Property, Plant and Equipment


You obtained the following information pertaining to Virginias property, plant and
equipment for 2016. Audited 2015 ending balances based on your working paper are as
follows:
Land
Buildings
Accumulated Depreciation Building
Machinery and Equipment
Accumulated Depreciation Machinery and Equipment
Delivery Equipment
Accumulated Depreciation Delivery Equipment
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P4,000,000
30,000,000
6,577,531
22,500,000
6,500,000
3,000,000
2,400,000
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The depreciation policies being implemented by Virginia are as follows:


Buildings
Machinery and Equipment
Delivery Equipment
Leasehold Improvements

Depreciation Method
150% declining balance
Straight-line
Sum of the years digits
Straight-line

Useful Life
25 years
10 years
5 years
10 years

Transactions during 2016 are as follows:


Jan. 2

Virginia purchased a new truck for P500,000 cash and traded-in a 2-year
old truck with a cost of P450,000 and a book value of P180,000. The new
truck has a cash price of P600,000. The market value of the old truck is
not known.

Apr. 1

A machine purchased for P600,000 on April 1, 2011 was destroyed by fire.


Virginia managed to recover P200,000 from its insurance company.

May 1

Virginia incurred costs of P4,500,000 to improve the leased office. The


lease terminates on December 31, 2022.

July 1

Machinery and equipment were purchased at a total invoice cost of P7


million. Additional costs of P150,000 and P650,000 were incurred for
freight and installation respectively.

Additional information:
Virginia determined that the delivery equipment comprising the P3,000,000 beginning
balance would have been depreciated at a total amount of P400,000 for the year.

1. How much is the accumulated depreciation buildings as of December 31, 2016?


2. How much is the accumulated depreciation machinery and equipment as of
December 31, 2016?
3. How much is the accumulated depreciation delivery equipment as of December 31,
2016?
4. How much is the accumulated depreciation leasehold improvements as of
December 31, 2016?
5. How much is the net gain (loss) on disposal for the year ended 2016?
Problem 7-6 Self-constructed assets
On January 1, 2016, Angelo Corporation contracted with De Leon Construction to
construct a building for P40 million on a land that Angelo purchased several years ago.
The contract provides that Angelo is to make five payments in 2016, with the last
payment scheduled for the date of completion. In order to finance the construction,
Angelo entered into a 4-year note with 12% interest on January 1, 2016 with interest
compounded quarterly. Principal of P15 million and interest are payable upon maturity.
The building was completed on December 31, 2016. Angelo made the following
payments during 2016:
January 1
P 4,000,000
March 31
8,000,000
June 30
12,000,000
September 30
9,000,000
December 31
7,000,000
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Angelo also has a P10 million 10%, 10-year note dated January 1, 2013 with interest
payable annually on December 31 and a P15 million, 12%, 5-year note dated January 1,
2014 with interest payable annually.

1. How much is the interest that would be capitalized during 2016?


2. How much is the interest that would be expensed during 2016?
Problem 7-7 Self constructed assets
HERPETOTOMY had the following loans outstanding during 2015 and 2016:
10% specific construction loan
12% general loan

600,000
5,000,000

HERPETOTOMY began construction of a building for its own use on January 1, 2015
and was completed on December 31, 2016. The following expenditures were made
during 2015 and 2016:
January 1, 2015
April 1, 2015
December 1, 2015
March 1, 2016

800,000
1,000,000
600,000
1,200,000

1. Assuming that the building was completed on December 31, 2016, how much is the
cost of the building on December 31, 2016?
2. Assuming that the building was completed on June 30, 2016, how much is the cost of
the building?
3. Assuming that the building was completed on December 31, 2016 and the specific
construction loan was also used for general purposes, how much is the cost of the
building?
Problem 7-8 Wasting Assets
In 2011, Orc Corporation acquired a gold mine in Lordaeron. Because of numerous
haunting and other supernatural reasons, Orc was able to acquire the mine for a low, low
price of P50,000. Experts estimated that 4 million tons of gold could be obtained from the
mine.
In 2012, Orc constructed a road to the mine costing P5,000,000. Improvements made to
the mine in 2011 amounted to P750,000. Because of the improvements to the mine and
the surrounding land, it is estimated that the mine can be sold for P600,000 when the
mining activities are completed.
During 2013, several townhouses were constructed near the site to house the
employees. Total cost of the townhouses was P1,500,000. Estimated residual value is
P250,000.
During 2014, the first year of operations, only 5,000 tons of gold were collected from the
mine. In 2015, the employees were able to mine 1 million tons of gold. Geologists
discovered that the mine actually contained 3 million tons more than the original
estimation. Improvements of P275,000 were made to the mine early in 2015 to facilitate
the removal of the additional gold. Furthermore, an additional townhouse was
constructed at a cost of P225,000 for the additional employees that would be hired to
obtain the additional gold. The new townhouse was not expected to have any residual
value.
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In 2016, 2.5 million tons of gold were mined and costs of P1,100,000 were incurred at
the beginning of the year for improvements to the mine.

1.
2.
3.
4.
5.

How much was the depletion to be recognized in 2014?


How much was the depletion to be recognized in 2015?
How much is the depletion to be recognized in 2016?
How much is the depreciation to be recognized in 2015?
How much is the depreciation to be recognized in 2016?

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