De La Salle Araneta University

Accountancy Department

Auditing Problems Jonathan P. Binaluyo, CPA, MBA

Audit of Shareholder’s Equity badyangpogi

Account Balance Audit Objectives

 All the equity accounts on the balance sheet either:

(a) represent shares or other units of ownership that are appropriately authorized, issued, and outstanding; or
(b) reflect other properly authorized transactions that are appropriately recorded in the equity accounts.

 All the shares or other units of ownership that are appropriately authorized, issued, and outstanding, and all other properly
authorized transactions that affect the equity accounts at the balance sheet date are included in the equity accounts.

 The equity accounts are stated on the balance sheet at the appropriate amounts.

 Share options, share purchase plans, share purchase warrants, conversion privileges, or other contingent share issuances that
exist have been appropriately recognized.

 The equity accounts are properly classified, described and disclosed in the financial statements, including notes, in conformity
with prescribed accounting principles.

Primary Substantive Procedures

1. Obtain an equity reconciliation schedule, including retained earnings, agree to general ledger accounts and test movements
from prior year end to current year end to ensure proper accounting for changes in equity, (e.g., profit distributions, other
equity reductions or increases) and determine completeness and compliance with laws and regulations including taxation
issues.

2. Review the minutes and other supporting documents for the authorization for, and the details of, the transactions that
affected the equity accounts and disclosures during the period, including equity restrictions.

3. Review board or authorized committee minutes and inquire of management for any share option agreements. Determine
that options have been appropriately accounted for and disclosed.

4. Ensure that all dividend payments are appropriately approved and declared, and that tax regulations have been followed.

5. Confirm the capital share authorized and issued and, when applicable, the treasury shares held with the transfer agent and
registrar; confirm the partners’ or the proprietor’s account balances. If the client acts as its own transfer agent, examine
the share certificate book or the detailed records to determine that numbers of authorized shares and outstanding shares;
inspect unused certificates on hand; test the issuance and cancellation of shares during the period.

CASE 1
The following data were compiled prior to preparing the balance sheet of the Consider Corporation as of December 31,
2019:
Authorized ordinary shares, P100 par value P4,000,000
Cash dividends payable 160,000
Donated capital 800,000
Gain on sale of treasury shares 80,000
Net unrealized loss on equity securities at other comprehensive income 96,000
Premium on capital shares 320,000
Premium on bonds payable 240,000
Reserve for bond sinking fund (appropriation) 400,000
Reserve for depreciation 600,000
Revaluation increment on property 800,000
Retained earnings, unappropriated 720,000
Subscribed ordinary shares 480,000
Shares subscriptions receivable (2 years) 120,000
Shares warrants outstanding 200,000
Treasury shares, at cost 144,000
Unissued ordinary shares 800,000

Compute for the following:

1. Ordinary shares issued
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 a. P 4,000,000 b. P3,200,000 c. P 3,000,000 d. P2,800,000

2. Total share premium

a. P880,000 b. P1,200,000 c. P1,400,000 d. P1,500,000

3. Retained earnings – appropriated

a. P544,000 b. P400,000 c. P300,000 d. P0

4. Total shareholders’ equity

a. P6,784,000 b. P6,584,000 c. P6,320,000 d. P6,640,000

5. Total legal capital

a. P3,200,000 b. P3,680,000 c. P3,400,000 d. P3,700,000

CASE 2
Badyang Company had the following transaction related to declaration dividends in the current period (2019) under your
audit, you determined that no entries were made by the accountant to reflect the transaction related to dividend to ensure that
the balance of retained earnings is at optimum level in the financial statement. You gather evidences and based on the minutes
of the board meetings, you summarized it below:

Share dividend
Badyang Company has 500,000 shares of P10 par value ordinary shares outstanding. In declaring and distributing 10% share
dividend, Badyang Company issued only 46,000 new shares, the other share dividend was not issued because some investors
did not own Badyang Company’s shares in even multiples of ten. To these shareholders, Badyang Company issued fractional
warrants. Badyang Company’s ordinary shares were selling at P25 per share when the share dividends were declared.
Ultimately, only 90% of the fractional share warrants were finally turned-in in exchange of full shares.

At the end of the year Badyang Company declared a P2 per share cash dividend.

Property Dividend
On October 31, Badyang Company declared a building held as owner-occupied property with an original life of 10 years as
dividend distributable to stockholders on January 31 of the following year. This was acquired at P800,000 on October 31,
2018. The property had fair market value P900,000 on October 31, 2019. On December 31, 2019 the value of the property
declined to P700,000.

The property was transferred to shareholders on January 31, 2020 when the prevailing fair value was at P800,000.

Determine the following:

1. How much is the total amount charge to retained earnings in 2019 related to dividend transactions?
a. P3,529,200 b. P3,440,000 c. P3,249,200 d. P3,049,200

2. The entry to record the distribution of share dividends and the fractional warrants will include a credit to Fractional
share warrants of?
a. P40,000 b. P36,000 c. P30,000 d. P50,000

3. The entry to record the surrender and exercise of the 90% fractional warrants will include a credit to Ordinary share
capital of?
a. P40,000 b. P36,000 c. P30,000 d. P50,000

4. Assuming that the remaining fractional warrants expire, what is the increase in total share premium?
a. P7,000 b. P6,000 c. P4,000 d. P0

5. What is the gain or loss to be recognized in the profit or losses as a result of the distribution of the property dividends
on January 31?
a. P100,000 b. P200,000 c. P220,000 d. P250,000

CASE 3
On January 2019, the board of directors of Avengers Inc. authorized the grant of share options per employee to supplement
the salaries of 100 of its key employees. Each share option permits the purchase of one share of Avengers ordinary share at
a price of P25 per share (par value P15). The market price of the share on January 1, 2019 is P40 per share.

Share Option Plan: (For 100 employees)

The board of directors of Avengers Inc. authorized the grant of 100 share options per employee The option which has a
market value of P25 vests, or become exercisable, beginning on January 1, 2022, if the employees stay with the company for
the entire three-year vesting period and provided further that market price of shares reaches P60 at the end of the vesting
period. The options shall expire on December 31, 2023.

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The following information were deemed relevant for the computation of the compensation expense for each year:
Estimated number of
Employees who will leave the
Date company (Option A only) Share market price
Dec. 31, 2019 20 P50
Dec. 31, 2020 25 P55
Dec. 31, 2021 30* P61
*Actual number of employees who left the company.

1. How much is the total compensation expense recognized for the share option plan in 2019?
a. P66,667 b. P58,333 c. P50,000 d. P120,833 e. P0

2. How much is the total compensation expense recognized for the share option plan in 2020?
a. P66,667 b. P58,333 c. P50,000 d. P120,833 e. P0

3. How much is the total compensation expense recognized for the share option plan in 2021?
a. P66,667 b. P58,333 c. P50,000 d. P120,833 e. P0

4. Assuming that the fair market value of shares on December 31, 2021 was at P58, how much is the total compensation
expense recognized for share option plan in 2021?
a. P66,667 b. P58,333 c. P50,000 d. P120,833 e. P0

5. Assuming that the fair market value of shares on December 31, 2020 was at P60, how much is the total compensation
expense recognized in 2020?
a. P66,667 b. P58,333 c. P50,000 d. P120,833 e. P0

CASE 4
Following is the shareholders’ equity section of Thorn Corporation’s statement of financial position at December 31, 2018:

Ordinary shares, P10 par value; authorized

shares; issued and outstanding 900,000 shares P9,000,000 P9,000,000
Share premiums 750,000
Retained earnings 2,700,000
Total shareholders’ equity P12,450,000

Transactions during 2019 and other information relating to the shareholders’ equity accounts were as follows:
a. On January 26, Thorn reacquired 75,000 shares of its Ordinary shares for P11 per share.

b. On April 4, Thorn sold 45,000 shares of its treasury shares for P14 per share.

c. On June 1, Thorn declared a cash dividend of P1 per share, payable on July 15, 2019 to shareholders of record on July
1, 2019.

d. On August 15, each shareholder was issued one shares right for each share held to purchase two additional shares of
shares for P12 per share. The rights expire on October 31, 2019.

e. On September 30, 150,000 shares rights were exercised when the market value of the shares was P12.50 per share.

f. On November 2, Thorn declared a two for one shares split-up and charged the par value of the shares from P10 to P5
per share. On November 20, shares were issued for the shares split.

g. On December 5, 60,000 shares were issued in exchange for secondhand equipment. It originally cost P600,000, was
carried by the previous owner at a book value of P300,000, and was recently appraised at P390,000.

h. Net income for 2019 was P720,000.

Based on the above and the result of your audit, determine the following as of December 31, 2019:
1. Ordinary shares
a. P12,600,000 b. P10,800,000 c. P10,050,000 d. P12,300,000

2. Total share premium

a. P1,485,000 b. P1,575,000 c. P3,825,000 d. P1,275,000

3. Un-appropriated retained earnings

a. P2,550,000 b. P2,422,500 c. P2,220,000 d. P2,190,000

4. Total shareholders’ equity

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 a. P16,425,000 b. P14,295,000 c. P16,095,000 d. P16,065,000

CASE 5
The shareholders’ equity section of the Turbo Inc. showed the following data on December 31, 2018:

Ordinary share, P3 par, 450,000 shares authorized, 375,000 shares issued and outstanding, P1,125,000; Share premium –
ordinary, P10,575,000; Share options outstanding, P225,000; Retained earnings, P720,000. The share options were granted
to key executives and provided them the right to acquire 45,000 shares of ordinary shares at P35 per share. Each option has
a fair value of P5 at the time the options were granted.

The following transactions occurred during 2019:

Feb. 1 Key executives exercised 6,750 options outstanding at December 31, 2018. The market price per share was
P44 at this time.

Apr. 1 The company issued bonds of P3,000,000 at par, giving each P1,000 bond a detachable warrant enabling the
holder to purchase two shares of share at P40 each for a 1-year period. The bonds would sell at 996 per
P1,000 bond without the warrant.

July 1 The company issued rights to shareholders (one right on each share, exercisable within a 30-day period)
permitting holders to acquire one share at P40 with every 10 rights submitted. All but 9,000 rights were
exercised on July 31, and the additional share was issued.

Oct. 1 All warrants issued in connection with the bonds on April 1 were exercised.

Dec. 1 The market price per share dropped to P33 and options came due. Because the market price was below
the option price; no remaining options were exercised.

Dec. 31 Net income for 2019 was P375,750.

Based on the above and the result of your audit, determine the following as of December 31, 2019:
1. Ordinary share
a. P1,165,950 b. P1,250,775 c. P1,275,075 d. P1,273,050

2. Total share premium

a. P12,629,175 b. P11,283,300 c. P12,329,475 d. P12,604,200

3. Retained earnings
a. P870,750 b. P1,095,750 c. P1,287,000 d. P981,225

4. Total shareholders’ equity

a. P13,545,000 b. P15,000,000 c. P14,676,000 d. P14,973,000

CASE 6
You were assigned to audit the shareholders’ equity of Justice League Corp. for the year ended December 31, 2019. Justice
League Corp. was incorporated in early 2018 when it was authorized by SEC to issue 100,000 ordinary shares (P100 par) and
50,000 preference shares (P50 par). The following schedule reflects the company’s capital balances as of December 31, 2018:

Ordinary shares, 50,000 shares issued during the company’s incorporation at P150 P7,500,000
per share.
Preference shares, 20,000 shares issued in June 30, 2018 in exchange of a building 1,200,000
with a fair market value of P1,200,000
Retained earnings, which is the company’s net income in 2018 5,540,000
Total shareholders’ equity P14,240,000

Your inquiries and investigation revealed the following transactions which occurred in 2019:

a. In early 2019, the company reacquired 20,000 from its previously issued ordinary shares at P160 per share and reverted
them to treasury since it has an intent of reissuing the same.

b. On March 10, the company issued 10,000 ordinary shares (from previously unissued shares) and 10,000 preference shares
for a total lump sum of P2,800,000. On this date, ordinary shares are quoted in the market at P175 per share while
preference shares are quoted at P75 per share.

c. On June 19, the company issued, through a broker, additional 5,000 preference shares at P85 per share. The company
incurred P25,000 in broker’s fees and commission.

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d. On July 1, the company issued 15,000 ordinary shares with a 3 year- P2,000,000, 12% face value bonds for a total
consideration of P5,000,000. The bonds which pay semi-annual interest every January 1 and July 1, are currently quoted
at 110 while the ordinary shares are quoted in the market at P180 per share.

e. On October 11, the company reissued 8,000 treasury shares at P185 per share.

f. On December 1, the company retired 7,000 treasury shares and reverted them to unissued basis.

g. The company registered an adjusted net income in 2019 at P4,530,000.

Based on the information above, answer the following:

1. What is the balance of ordinary shares account as of December 31, 2019?
a. P5,000,000 b. P6,250,000 c. P7,050,000 d. P7,750,000

2. What is the balance of the preference shares account as of December 31, 2019?
a. P1,000,000 b. P1,500,000 c. P1,700,000 d. P2,000,000

3. What is the balance of the share premium - ordinary shares as of December 31, 2019?
a. P2,500,000 b. P3,610,000 c. P4,560,000 d. P4,910,000

4. What is the balance of the share premium - preference shares as of December 31, 2019?
a. P200,000 b. P340,000 c. P540,000 d. P600,000

5. What is the total share premium as of December 31, 2019?

a. P5,100,000 b. P5,230,000 c. P5,550,000 d. P5,700,000

6. What is the total contributed capital as of December 31, 2019?

a. P8,550,000 b. P13,240,000 c. P13,650,000 d. P13,780,000

7. What is the correct balance of the retained earnings – unappropriated account as of December 31, 2019?
a. P10,070,000 b. P9,270,000 c. P8,070,000 d. P7,940,000

8. What is the total shareholders’ equity as of December 31, 2019?

a. P23,850,000 b. P22,920,000 c. P21,920,000 d. P23,050,000

*** END ***

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