FAR EASTERN UNIVERSITY

Nicanor Reyes Sr. St. Sampaloc, Manila

Institute of Accounts, Business and Finance
2nd Semester 2018

AUDIT OF LIABILITIES AND RELATED ACCOUNTS PART 1

Payables
Account Balance Audit Objectives
 All accounts payable on the balance sheet are real debts due to suppliers or other creditors of the entity for goods
received or services performed.
 All accounts payable owed by the entity at the balance sheet date are included on the balance sheet.
 Accounts payable are stated at the amounts owed at the balance sheet date.
 The accounts payable on the balance sheet represent obligations of the entity at the balance sheet date. The accounts
payable are not secured by liens on assets, security interests, or other collateral unless otherwise indicated.
 Accounts payable are properly classified, described, and disclosed in the financial statements, including notes, in
conformity with prescribed accounting principles.

Primary Substantive Procedures

N1. Agree the accounts payable sub ledger to the general ledger control account and investigate large and unusual
reconciling items.
N2. Inquire about or perform a review of accounts payable sub ledger for unusual items, e.g., significant debit balances in
the accounts payable sub ledger or other unexpected amounts to verify proper classification and valuation.
N3. Perform cutoff tests for goods and services received as well as for supplier credit memos to ensure that transactions
are completely recorded in the correct period.
N4. Perform a search for unrecorded liabilities at the year-end date by selecting subsequent disbursements and unmatched
invoices and receiving reports.
N5. Compare supplier balances post year end to those at year end and investigate unusual or significant changes.
N6. Test appropriate valuation of accounts payable in foreign currencies.

Other Substantive Procedures

 Compare the list of accounts payable with those of prior periods and investigate any unexpected changes (e.g., changes
in major vendors, in the proportion of debit balances, in the aging of the accounts) or the absence of expected changes.
 Compare the number of days’ purchases in accounts payable with prior years.

Provisions

Account Balance Audit Objectives

 Product warranty liabilities on the balance sheet have accrued or are real debts of the entity.
 Product warranty liabilities that have accrued at the balance sheet date are included on the balance sheet.
 Product warranty liabilities are included on the balance sheet at the appropriate amounts, and related expenses are being
allocated to the periods in which they are incurred.
 Product warranty liabilities on the balance sheet represent obligations of the entity at the balance sheet date which are not
secured by liens on assets, security interests, or other collateral nor have they been assumed or guaranteed by others
unless otherwise indicated.
 Product warranty liabilities are properly classified, described, and disclosed in the financial statements, including notes,
in conformity with prescribed accounting principles.

Other Substantive Procedures

 Compare current year’s to prior year’s reserve, charges and related expense.
 Compare current year’s to prior year’s warranty expense by product and/or geographical area (i.e., domestic or foreign) as
a percentage of sales and cost of sales or units sold.
 Compare warranty experience to patterns in the client’s industry.
 Compare aged analysis of the warranty accruals with warranty expiration dates.
 Compare actual expenditures for product warranty liabilities with the amounts claimed.

THEORETICAL CONCEPTS
1. The accounts payable department receives the purchase order to accomplish all the following except
a. Comparing the invoice price to the purchase order price.
b. Ensuring that the purchase had been properly authorized.

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 c. Ensuring that the goods had been received by the party requesting them.
d. Comparing the quantity ordered to the quantity purchased.

2. For effective internal control, which of the following individuals should be responsible for mailing signed checks?
a. Receptionist
b. Treasurer
c. Accounts payable clerk
d. Payroll check

3. You are auditing the December 31, 2018, accounts payable balance of one of your firm’s divisions. The division
controller’s office has provided you with a schedule listing the creditors and the amount owed to each at December
31, 2018. Which of the following audit procedures would be your best choice for determining that no individual
account payable has been omitted from the schedule?
a. Send confirmation requests to a randomly selected sample of creditors listed on the schedule.
b. Send confirmation requests to creditors that are listed on the schedule but not listed on the corresponding
December 31, 2017, schedule.
c. Examine support for selected January 2019 payments to creditors, ascertaining that those relating to 2019
are not on the schedule.
d. Examine support for selected January 2019 payments to creditors, ascertaining that those relating to 2018
are on this schedule.

4. A preliminary survey of the purchasing function indicates the following:

a. Department managers initiate purchase requests, which must be approved by the plant superintendent.
b. Purchase orders are typed by the purchasing department by using the prenumbered and controlled forms.
c. Buyers regularly update the official vendor listing as new sources of supply become known.
d. Rush orders can be placed with a vendor by telephone but must be followed by a written purchase order
before delivery can be accepted.
e. Vendor invoice payment requests must be accompanied by a purchase order and a receiving report.

One possible fault of this system is that

a. Purchases can be made at prices higher than normal from a vendor controlled by a buyer.
b. Unnecessary supplies can be purchased by department managers.
c. Payment can be made for supplies not received.
d. Payment can be made for supplies received but not ordered by the purchasing department.

5. Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?
a. Vouch a sample of accounts payable entries recorded just before year end to the unmatched receiving report
file.
b. Compare a sample of purchase orders issued just after year end with the year-end accounts payable trial
balance.
c. Vouch a sample of cash disbursements recorded just after year end to receiving reports and vendor
invoices.
d. Scan the cash disbursements entries recorded just before year end for indications of unusual transactions.

6. For effective internal control, the accounts payable department generally should
a. Stamp, perforate, or otherwise cancel supporting documentation after payment is mailed.
b. Ascertain that each requisition is approved as to price, quantity, and quality by an authorized employee.
c. Obliterate the quantity ordered on the receiving department copy of the purchase order.
d. Establish the agreement of the vendor’s invoice with the receiving report and purchase order.

7. In testing controls over cash disbursements, an auditor most likely would determine that the person who signs checks
also
a. Review the monthly bank reconciliation.
b. Returns the checks to accounts payable.
c. Is denied access to the supporting documents.
d. Is responsible for mailing the checks.

8. Which of the following internal control activities is not usually performed in the vouchers payable department?
a. Matching the vendor’s invoice with the related receiving report.
b. Approving vouchers for payment by having an authorized employee sign the vouchers.
c. Indicating the asset and expense accounts to be debited.
d. Accounting for unused pre-numbered purchase orders and receiving reports.

9. In assessing control risk for purchases, an auditor vouches a sample of entries in the voucher register to the supporting
documents. Which assertion would this test of controls most likely support?

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 a. Completeness
b. Existence or occurrence
c. Valuation or allocation.
d. Rights and obligations.

10. An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash
disbursements journal. The purpose of this substantive audit procedure most likely was to
a. Identify unusually large purchase that should be investigated further.
b. Verify that cash disbursements were for goods actually received.
c. Determine that purchases were properly recorded.
d. Test whether payments were for goods actually ordered.

CASE 1
The Man on Wire Company’s chief accountant provided the following information in relation to your audit of liabilities
for the year 2018:

Notes payable:
Arising from purchase of goods P504,000
Arising from 5 year bank loans, on which a inventories valued at
P600,000 have been pledge as security, P400,000 due on June 30,
2019; and another P300,000 due on December 31, 2020. 700,000
Arising from advances by officers, due June 30, 2019 90,000
Reserve for general contingencies 450,000
Employees income tax withheld 50,000
Advances received from customers on purchase orders 84,000
Containers deposit 80,000
Accounts payable arising from purchase of goods, net of debit balances of P30,000 220,000
Accounts receivable, net of credit balances of P40,000 360,000
Cash dividends payable 80,000
Share dividend payable 100,000
Dividend in arrears on preference shares 200,000
Convertible bonds, due January 31, 2020 1,500,000
First mortgage on serial bonds, payable in semi-annual installments of P50,000, due
April 1 and October 1 of each year. 2,000,000
Overdraft with BPI bank 90,000
Cash in bank balance with BDO 390,000
Estimated liability for damages 160,000
Estimated liability on meeting guaranteed for service requirements on merchandise 120,000
Estimated liability for premiums 75,000
Deferred revenue due in 12 months 87,000
Accrued interest on bonds payable 360,000
Share warrants outstanding 120,000
Share options outstanding 210,000
Unused letter of credit 400,000

On March 1, 2019, the P400,000 note payable was replaced by an 18-month note for the same amount. The entity is
considering similar action on the P300,000 note payable due on December 31, 2020. The 2018 financial statements were
authorized for issue on March 31, 2019.

On December 31, 2018, a former employee filed a lawsuit seeking P200,000 for unlawful dismissal. The entity’s attorney
believed that the suit is without merit. No court date has been set.

Determine the following as of December 31, 2018:

1. Total current liabilities:
2. Total noncurrent liabilities:

CASE 2
You are auditing the 2018 liabilities of Versace on the Floor Inc. which follows the calendar year financial statements
reporting. The following information were available with regard its currently maturing obligations:

Accounts payable control account P4,450,000

Accounts payable – subsidiary ledger 4,020,000
Notes payable 3,000,000

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Audit notes:
a. The accountant of Versace on the floor Inc. provided you the following reconciliation of accounts payable control
account and subsidiary ledger account in connection with your audit of its accounts payable account for the period
ended December 31, 2018:

Balance per control account (General ledger) P4,450,000

Goods received on December 30, purchase invoice not yet received from supplier (400,000)
Purchase invoice on goods still in transit as of December 31, 2018. Term FOB destination. 300,000
Payments to suppliers in which checks were released on December 30, 2018 (520,000)
Payments to suppliers in which checks were released on January 2, 2019 200,000
Purchase returns (50,000)
Credit balance on a suppliers’ account 40,000
Balance per subsidiary ledgers P4,020,000

b. On December 31, 2018, Versace had P1M of short-term notes payable due February 7, 2019. On January 15, 2019,
the company issued bonds with a face value of P900,000 at 96; brokerage fees and other costs of issuance were
P3,450. On January 22, 2019, the proceeds from the bond issue plus additional cash held by the company on
December 31, 2018 were used to liquidate the P1M of short-term notes.

c. Another short-term debt in the form of notes payable totaling to P500,000 were due on June 1, 2019. On February 2,
2019, Versace entered an agreement with PhilAm Life Insurance Co. whereby PhilAm will lend Versace P400,000
payable in 5 years at 14%, the proceeds of which is intended to be used to partly refinance the said notes. The money
will be available to the company on May 20, 2019.

d. Another P500,000 notes payable is due on June 15, 2019. At the financial statement date December 31, 2018,
Versace signed an agreement to borrow up to P500,000 to refinance the notes payable on a long-term basis. The
financing agreement called for borrowings not to exceed 80 per cent of the value of the collateral Versace was
providing. At the date of issue of the December 31, 2018 financial statements, the value of the collateral was
P600,000 and was not expected to fall below this amount during 2019.

e. Versace Inc. also have a P1,000,000, 10%, outstanding 5-year bonds payable due December 31, 2022. Interest on the
bonds is payable every December 31. By the end of 2018 however, due to shortage in working capital, Versace Inc.
was not able to pay the interest due December 31, 2018. As a result, the liability became demandable by the bond
holder. On December 31, 2018 Versace Inc. was able to obtain a waiver (grace period) from the bond holder up to
March 31, 2019 since by then Versace Inc. expects to have enough cash to settle the interest due. The bondholder will
not be demanding the payment of the bond during the said grace period.

Determine the following:

1. How much is the accounts payable in the financial statement?
2. How much is the total current notes payable?
3. How much is the total current liabilities?
4. How much is the total non-current liabilities?

CASE 3
You were engaged to audit the liabilities section of Army of Angels Company for the period ended December 31, 2018.
The following selected transactions were noted during your inquiry and inspection of documents for the period ending
December 31, 2018:

Notes payable:
a. March 1, 2018, borrowed P25,000 on a two-year, 12 percent, interest bearing note. Interest is paid yearly.
b. April 1, 2018, borrowed cash and signed a P20,000, two-year, noninterest bearing note. The market rate of interest for
this level of risk was 16 percent.
c. January 1, 2018, purchased a special truck with a list price of P33,000. Paid P3,000 cash and signed a P30,000, three
year, 10%, interest bearing note payable in equal payments every December 31 starting 2018 plus interest based on
outstanding balance. The market rate of interest for this level of risk was 16 percent.

Warranties:
Army of Angels sells compact stereo systems with a two-year warranty. Past experience indicates that 10% of all sets
sold will need repair in the first year, and 20% will need repairs in the second year. The average repair cost is P500 per
system. The company was able to sell 5,000 units and 6,000 units in 2017 and 2018, respectively. Actual repair costs
were P325,000 in 2017 and P650,000 in 2018. All repair costs involved cash expenditures and were all charged to
warranties expense on the year of incurrence. No accrual for additional warranty liability was made by the company at
year end.

Premiums:
To increase sales, on January 1, 2018, Army of Angels Company inaugurated a two-year sales promotional plan. The
sales promotional plan entitles customer to purchase certain premium items at a very minimal price plus presentation of
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certain amount of accumulated official receipts on purchases. The following table summarizes the sales promotional plan
mechanics:
Required accumulated Number of premium
official receipt amount Minimal items purchased Purchase price of the
Premium item to be presented purchase price during the period premium items
Vacuum cleaner P15,000 P500 1,000 P2,250
Industrial stand fan 12,500 300 1,500 1,500

Total cash sales during the period amounted to P45,000,000. The company estimates that 30% of the total receipts for the
year will be presented by the customers to redeem vacuum cleaner premium while 40% of the total receipts will be
presented to redeem industrial stand fan.

The company’s count of the premium items remaining on hand on December 31, 2018 revealed that there were 175
vacuum cleaners and 125 industrial stand fan on hand.

Other matters:
a. A customer is suing Army of Angels Company for P800,000 in damages because her child Shonga was injured in
November 2018 while riding an escalator that stopped suddenly in one of its state of the art store in Makati. The child
was hurt, feeling broken down, and feeling the pain from the inside and out, when he tripped and fell while walking
down an escalator that was going up. Legal counsel feels that the child is partially at fault, and so deserves all the
pain, but that it is probable that the lawsuit will be settled for between P50,000 and P100,000, with P90,000 being the
most likely amount.

b. Army of Angels Company has an incinerator behind of its state of the art facility in Makati which is used to burn
cardboard boxes received in shipments of inventory from suppliers. The environmental protection agency filed a suit
against the company in August 2018 for air pollution. The company expects to stop using incinerator and began
recycling. However, its lawyers believe that is it probable that a fine of between P40,000 and P80,000 will be levied
against the company, although they cannot predict the exact amount.

Determine the following as of December 31, 2018:

1. How much of the notes above are reported as current in 2018?
2. How much is the warranty expense in 2018?
3. The balance of estimated liability for warranty at the end of 2018 is?
4. How much is the premium expense in 2018?
5. The balance of estimated premium claims outstanding at end of 2018 is?
6. Interest payable on the notes at the end of 2018 is?
7. How much is the total current liabilities?
8. As an auditor, your proposed adjusting entry for the other matters will include?

CASE 4
Arms Open Corporation, a client, requests that you compute the appropriate balance of its estimated liability for product
warranty account for a statement as of June 30, 2018.

Arms Open Corporation manufactures television components and sells them with a 6-month warranty under which
defective components will be replaced without charge. On December 31, 2017, Estimated Liability for Product warranty
had a balance of P620,000. By June 30, 2018, this balance had been reduced to P120,400 by debits for estimated net cost
of components returned that had been sold in 2017.

The corporation started out in 2018 expecting 7% of the peso volume of sales to be returned. However, due to the
introduction of new models during the year, this estimated percentage of returns was increased to 10% on May 1. It is
assumed that no components sold during a given month are returned in that month. Each component is stamped with a
date at time of sale so that the warranty may be properly administered. The following table of percentages indicates the
likely pattern of sales returns during the 6-month period of the warranty, starting with the month following the sale of
components.
Percentage of Total
Month Following Sale Returns Expected
First 30%
Second 20
Third 20
Fourth through sixth—10% each month 30
100%
Gross sales of components were as follows for the first six months of 2018:
Month Amount Month Amount
January P4,200,000 April 3,250,000
February 4,700,000 May 2,400,000
March 3,900,000 June 1,900,000
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The corporation’s warranty also covers the payment of freight cost on defective components returned and on the new
components sent out as replacements. This freight cost runs approximately 5% of the sales price of the components
returned. The manufacturing cost of the components is roughly 70% of the sales price, and the salvage value of returned
components averages 10% of their sales price. Returned components on hand at December 31, 2018, were thus valued in
inventory at 10% of their original sales price.

Based on the given information, determine the following:

1. Total estimated returns from the sales made during the first 6 months of 2018
2. Total estimated returns subsequent to June 30, 2018
3. Estimated loss on component replacement (in percentage of sales price)
4. Required Estimated Liability for Product Warranty balance at June 30, 2018
5. Required adjustment to liability account

CASE 5
You have conducted several wrap-up audit procedures for Hall of Fame Corp.’s financial statements audit for the calendar
year ended December 31, 2018. The financial statements were authorized for issue by Hall of Fame Corp.’s board on
March 30, 2019. As part of these procedures you gathered corroborating evidences with regard the provisions and
contingencies, the following were noted:

Note 1: On December 31, the company is a defendant in a pending lawsuit which arose from an alleged product defect
that the company sold in 2018. The lawyers, in response to a letter of audit inquiry, stated that it is probable that the
company have to pay between P300,000 to P700,000, with P400,000 as the best estimate. Moreover, it is reasonably
possible that the company will have to pay the P700,000 as a result of the lawsuit.

Note 2: On November 1, 2018, the company entered into a non-cancellable purchase commitment with Sharp Inc. to
acquire 10,000 units of a specific product at P100 per unit fixed price. The purchase commitment is expected to be
executed on February 1, 2019. On December 31, 2018, because of a significant decline in the demand for Sharp’s
products, the net realizable value of the product decreased to P60 per unit. The contract was executed on February 1, 2019
when the net realizable value of the product remained P60.

Note 3: On December 30, 2018 an explosion occurred at the company’s plant totally damaging the plant and causing
additional damages to adjacent neighbors. The carrying value of the plant on the company’s books was at P5M. It had a
prevailing fair value of P4M prior to the explosion. No claims had yet been asserted against the company as of the date of
authorization of the financial statements. The management as corroborated by their counsel, however believes that it its
probable that the company would be responsible for damages and that P5,000,000 would be a reasonable estimate of its
liability. Hall of Fame Corp.’s had an insurance covering this type of accident. The insurance shall reimburse the
company at 80% of the prevailing fair value of the asset prior to the fire while it shall reimburse the company 80% of any
payments to be made for damages caused to neighbors. The reimbursements are virtually certain and that the company is
no longer principally liable over the portion to be reimbursed for damages to other parties.

Note 4: On December 5, 2018 Hall of Fame Corp. initiated a lawsuit against Lore Inc. seeking P2 million in damages
from patent infringement. The lawyers are under the impression that the will likely win the case with the damage being
sought to be awarded to Hall of Fame Corp.

Determine the following as a result of your audit:

1. For each of the following notations of the auditor, determine the proposed adjusting journal entries.
2. How much is the total current liabilities?
3. How much is the total non-current liabilities?

CASE 6
You were able to obtain the following from the accountant for Maverics Corp. related to the company’s liability as of
December 31, 2018.

Accounts payable P650,000

Notes payable – trade 190,000
Notes payable – bank 800,000
Wages and salaries payable 15,000
Interest payable ?
Mortgage notes payable – 10% 600,000
Mortgage notes payable – 12% 1,500,000
Bonds Payable 2,000,000

The following additional information pertains to these liabilities:

a. All trade notes payable are due within six months of the balance sheet date.

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b. Bank notes payable include two separate notes payable Allied Bank.
(1) A P300,000, 8% note issued March 1, 2018, payable on demand. Interest is payable every six months.
(2) A 1-year, P500,000, 11 ½% note issued January 2, 2018. On December 30, 2018 Mavericks negotiated a written
agreement with Allied Bank to replace the note with 2-year, P500,000, 10% note to be issued January 2, 2019.
The interest was paid on December 31, 2018.

c. The 10% mortgage note was issued October 1, 2019. With a term of 10 years. Terms of the note give the holder the
right to demand immediate payment of the company fails to make a monthly interest payment within 10 days of the
date the payment is due. As of December 31, 2018, Mavericks is three months behind in paying its required interest
payment.

d. The 12% mortgage note was issued May 1, 2012, with a term of 20 years. The principal amount outstanding is
P1,500,000. Principal and interest payable annually on April 30, A payment of P220,000 is due April 30, 2019. The
payment includes interest of P 180,000.

e. The bonds payable is 10-year, 8% bonds, issued June 30, 2009. Interest is payable semi-annually every June 30 and
December 31.

Based on the above and the result of your audit, answer the following:
1. Interest payable as of December 31, 2018 is?
2. How much is the total current notes payable?
3. How much is the total non-current notes payable?
4. Total current liabilities as of December 31, 2018?
5. Total noncurrent liabilities as of December 31, 2018 are?

CASE 7
Rock the World Corp. began operation on January 2, 2017 with 250 employees. The company provides its employees 2
weeks paid sick leave and 2 weeks paid vacation leave for every operating year. The company’s policy on sick leave and
vacation leave allows each employee to carry over accumulated leaves for the current period over the next year only. The
same shall be forfeited if not availed of over the said period allowed.

On December 31, 2017, records show that there are 55 employees who are yet to avail of any leaves, while there are 25
employees who have remaining 2 weeks unused vacation and sick leaves combined. Employees had an average daily
wage rate of P250 for a 5-day weekly operation in 2017.

On December 31, 2018, records show that 925 days’ vacation and sick leaves carried over from the last operating period
were exercised and paid in 2018. In addition, there are 30 employees who have 6 weeks accumulated unused sick leave
and vacation leaves combined; 25 employees who have accumulated 3 weeks unused sick leaves and 2 weeks unused
vacation leaves; 30 employees who have accumulated 3 weeks unused sick leave and vacation leaves combined; 10
employees who have accumulated 1 week unused sick leaves and 1 week unused vacation leaves. Employees had an
average daily wage rate of P275 for a 5-day weekly operation in 2018.

You have observed that there has been no accrual made by the client to accrue salaries payable for the unused leaves at the
end of 2017 and 2018.

Requirements:
1. What is the retroactive adjustment to retained earnings, beg. as a result of your audit?
2. How much liability for compensated absences should be included as current liabilities as of December 31, 2018?

CASE 8
Deliverance Company had the following transactions related to your audit procedures in bonds. The summary of issuance
of bonds during the period under audit was presented below:

Bond payable A
Deliverance Company issued a five-year bonds dated March 1, 2018 in the amount of P1,000,000. These bonds have an
annual coupon rate of 10% payable semi-annually every March 1 and September 1. The prevailing market rate of interest
on the date the bonds were issued was at 8%. Deliverance Company as planned was able to sell all of its bonds on March
1, 2018 at the prevailing market rate of interest. The entries prepared by the company were: 3/1: Debit to Cash and credit
to Bonds Payable for the total proceeds from the issuance of the bonds; 9/1 Debit to Interest expense and credit to Cash at
P50,000.

Bonds Payable B
On January 1, 2018, Deliverance Company issued a 3-year, 8,000, P1,000 convertible bonds at 110. Interest is to be paid
annually at the stated coupon rate of 12% every December 31. Each bond is convertible, at the holder’s option, into 50,
P10 par value common shares at any time up to maturity. On the date of issuance, prevailing market interest rate for
similar debt without the conversion privilege was 10%. On the same date market price of one common share was P30.

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The transaction was recorded as a debit to cash and credit to bonds payable for the total consideration received. Interest
payment at the end of the year was appropriately recorded as a debit to interest expense account.

Determine the following as a result of your audit:

1. How much is the total interest expense in 2018?
2. How much is the total carrying value of the bonds in 2018 financial statement?
3. The proposed adjusting entry related to bonds payable A in 2018 is?
4. The proposed adjusting entry related to bonds payable B in 2018 is?
5. Assuming that the convertible bonds above were converted on January 1, 2020, how much should be credited to
Share premium/Additional paid-in capital from the equity conversion?
6. Assuming that the convertible bonds above were retired on January 1, 2020 at 104, how much is the gain or loss on
the early retirement of the bonds to be reported in the income statement assuming that the bonds were selling at
101 without the conversion privilege at that time?

CASE 9
In line with your audit of Eden Inc.’s financial statement as of and for the period ended December 31, 2018, you were
provided the following liability balances:
Current Liabilities:
Accounts payable P1,240,000
Current provision 340,000
Noncurrent liabilities:
Bonds Payable P2,000,000

Audit notes:
a. Your purchases cut-off revealed the following entries to the purchases journal several days before and after December
31, 2018:

Purchases per December Purchases Journal

RR Number RR Date Amount Remarks
2901 12/26/2018 P20,000 FOB Destination
2902 12/28/2018 25,000 FOB Destination
2903 12/30/2018 30,000 FOB Shipping point (from consignor)

Purchases per January Purchases Journal

RR Number RR Date Amount Remarks
2904 1/3/2019 35,000 FOB Shipping point (in transit)
2905 1/4/2019 40,000 FOB Destination (in transit)
2906 1/5/2019 50,000 FOB Destination

b. Current provisions balance related to the accrued warranties payable on Eden’s promotional program which
commenced in the previous year. Eden allows customer to return merchandise for repairs for 1 year from date of
purchase free of charge. Eden sold 2,500 units of the merchandise covered by the said program in 2017 and 3,000
units of the same in 2018. The company estimates that 40% of the units sold shall be returned for repairs and that
average repair cost per unit is P900 in parts and labor. Actual warranty cost incurred in 2017 was P560,000. Actual
warranty cost incurred in 2018 was P700,000. Actual warranty costs were charged to warranty expense as incurred.

c. The bonds payable were issued on January 1, 2017 and are due on December 31, 2017. 12% Annual interest on the
bonds were payable every December 31. The bonds were issued to yield 10% interest. The company recorded the
issue by debiting cash for the proceeds and crediting bonds payable at face value. The difference was charged to
interest expense. Interest payments at the end of each year were debited to interest expense.

d. The company pays annual bonus to its key executives at 10% of the adjusted net income after 30% tax and after
bonus. The company registered net income before tax, bonus and any adjustment at P1,557,679.

Requirements:
1. What is the adjusted balance of Accounts Payable?
2. What is the adjusted balance of the Current Provision?
3. What is the correct carrying value of the bonds payable on December 31, 2018?
4. What is the accrued bonus as of December 31, 2018?
5. What is the adjusted net income after tax for 2018?

CASE 10
You auditing Awakening Corp.’s various liability accounts. The following schedule of liabilities was presented to you by
the company’s accountant in relation to your audit:

Accounts payable P460,000

Warranties payable 153,250
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 Salaries payable 268,500
10%, Note payable – bank 2,000,000

Audit notes:
a. You have rendered a purchases cut-off to ascertain the completeness of the company’s accounts payable balance.
The following is the summary of the entries 10 days before and after the balance sheet date and your audit
observations:

Purchases Journal Entries: Dec. 20 – Dec. 31, 2018:

Receiving Report Date Suppliers Invoice Date Amount FOB Term/Remark
Dec. 20, 2018 Dec. 19, 2018 60,000 Shipping Point
Dec. 23, 2018 Dec. 20, 2018 42,000 From Consignor
Dec. 28, 2018 Dec 26, 2018 45,000 Destination
Jan. 3, 2019 Dec. 29, 2018 30,000 Destination

Purchases Journal Entries: January 2 – January 10, 2019

Receiving Report Date Suppliers Invoice Date Amount FOB Term/Remark
Jan. 3, 2019 Dec. 28, 2018 P20,000 From Consignee
Jan. 5, 2019 Dec. 3, 2019 55,000 Shipping Point
Jan. 6, 2019 Jan. 3, 2019 84,000 Shipping Point
*note: assume suppliers’ invoice date as suppliers’ shipment date of goods and assume that the balance ending
inventories were correct and appropriately established through an inventory count and roll forward analysis.

b. The company started its 2-year warranty program for merchandise sold starting 2017. The company estimates that it
will incur P350 in part and labor for repairing each unit of merchandise. The company further estimates that 70% of
the units sold shall be returned for repairs and that 40% of the warranty costs shall be incurred in the year of sale
with 60% to be incurred in the year following the year of sale. The following information is deemed relevant for
your audit:
2017 2018
Number of units sold 1,250 1,410
Actual warranty costs 153,000 250,000

The balance of the warranties payable is the accrued warranty cost at the end of 2017. Actual warranty costs were
charged to current-year warranty expense. Adjusting entry at the end of 2018 is yet to be made.

c. Salaries payable reflects the probable unused sick leave and vacation leaves in 2017 and prior to 2017 carried over
2018. No entry had been made during the current year affecting the salaries payable account. Employees are
allowed to carry-over unused leaves over 2 years from year of grant, thereafter, it shall expire. Salary rates increased
for the current year by 10%. An analysis of the cumulative unused sick leave and vacation leaves are as follows:
d.
Prior to 2017 leaves carried over to 2018 270 days
2017 leaves carried over to 2018 625 days
Prior to 2018 leaves used in 2018* 700 days
Leaves earned in 2018 carried over 2019 550 days
*from prior to 2018 leaves used in 2018, 200 were earned by employees prior to 2017.

e. The 12% note payable to the bank was originated on June 30, 2012 and is due on June 30, 2019. Semi-annual
interest on the note is payable every June 30 and December 31. On December 31, 2018 the company has the option
of refinancing the liability by issuing another long-term debt security to the same bank due on June 30, 2016. The
proceeds of the loan to be made, as per agreement shall not exceed 80% of the fair market value of the property to be
attached to the loan as a collateral. As of the balance sheet date, the said property has a fair value of P2,000,000 and
is not expected to materially change until the refinancing transaction is completed.

f. The Board of Directors approved through a resolution, additional incentive to key officers in the form of a bonus
which shall be at 10% of the adjusted net income after 30% income tax and after bonus. The net income of the
company before any adjustments were made is at P2,032,700

Required:
1. What is the adjusted balance of the accounts payable account?
2. What is the balance of warranties payable as of December 31, 2018?
3. What is the correct balance of the salaries payable in the form of liability for compensated absences as of
December 31, 2018?
4. How much from the 10% notes payable shall be presented as non-current?
5. What is the correct amount of bonus to key officers?

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