AUDITING

COVID-19 Project for Accountants

AUDIT OF SHAREHOLDERS’ EQUITY:

Audit Objectives:

Assertions Account Balances Audit Objectives

Existence All the equity accounts on the statement of financial position
exist.
Completeness All equity interest that should have been recorded have been
recorded and included in the statement of financial position.
Valuation and The equity accounts are stated in the statement of financial
Allocation position at the appropriate amounts.
Presentation and Equity accounts are properly classified, described, and disclosed
Disclosure in the financial statements, including the notes to financial
statements, in accordance with the applicable financial reporting
framework.

Audit Procedures for Shareholders’ Equity:

Assertions and Audit

Audit Evidence and Procedures
Objectives
Existence, Completeness, A. Confirmation Evidence
Valuation and Presentation • Confirm equity balances with:
and Disclosure o Transfer agent if the stock transfer books are held
by a third party
• Are equity transactions o Corporate Secretary if the stock transfer books are
recorded at historical held by the corporation
cost?
B. Physical Evidence
• Are gains and losses • Examine treasury share certificates
recognized in the
shareholders’ equity C. Documentary Evidence
properly recognized? • Examine minutes of board meetings for authorization
of equity transactions
• Are equity transactions • Vouch dividend declarations and payments
authorized? (i.e. • Vouch treasury share transactions
issuance of shares, • Examine valuation where shares are issued for non-
dividends, splits, rights, cash assets.
etc.) • Examine loan agreements
• Examine share options agreements
• Are there any restriction • Examine articles of incorporation
and were these
disclosed? D. Mathematical evidence
• Recalculate earnings per share
• Were details relating to
the equity items
adequately disclosed?

“Courage doesn't always roar. Sometimes courage is the quiet voice at the end of the
day saying 'I will try again tomorrow’”
-Mary Anne Radmacher, American author and artist

1|Page jsabellar/rcsoriano
AUDITING

A. SUBSTANTIVE TESTING:

1. Where the Company does not employ an independent stock transfer agent and the
corporation issues its own stocks and maintains stock records, cancelled stock
certificates should
a. Not be defaced but segregated from other stock certificates and retained in a
cancelled certificates file.
b. Be destroyed to prevent fraudulent reissuance.
c. Be defaced and sent to the Secretary of the Department of Finance.
d. Be defaced to prevent reissuance and attached to their corresponding stubs.

2. ABC, Inc.’s board of directors declared and paid a 10% stock dividend. As an
independent external auditor, you must determine that
a. The shareholders received their additional shares by confirming year-end
holdings with them.
b. Appropriate amounts were debited from retained earnings to share capital
and share premium.
c. The stock dividend was properly recorded by means of a memorandum entry
only.
d. The officers authorized the issuance of the stock dividend.

3. An auditor usually obtains evidence on the authorization of shareholders’ equity

transactions by reviewing the entity’s
a. Minutes of the management’s meeting
b. Stock transfer book
c. Confirmation from the stock transfer agent
d. Minutes of the board of directors’ meeting

4. You were assigned in the audit of CPA Inc.’s shareholders’ equity accounts for the
calendar year-ended 31 December 2019. During the engagement team’s meeting,
the audit manager asked you to examine any restrictions to the retained earnings
arising from law, contracts or board of directors’ discretion. What assertion most
likely will be addressed by this testing?
a. Existence/Occurrence
b. Accuracy/Valuation
c. Presentation and Disclosure
d. Completeness

5. An audit program for the examination of the retained earnings account should
include a step that requires verification of the:
a. Market value used to credit retained earnings for 10% stock dividends
b. Approval of the adjustment to the beginning balance as a result of a write-
down of inventory due to obsolescence
c. Gain or loss resulting from the disposition of treasury shares
d. Authorization for dividends declared during the period.

2|Page jsabellar/rcsoriano
AUDITING

B. PROBLEM SOLVING
You were assigned in the audit of COVID-19, Inc. for the calendar year-ended 31
December 2020. As an associate, you were assigned in the audit of the Company’s
Shareholders’ Equity. Based on your initial assessment, the Company began operations
on 1 January 2015. You have also examined the Articles of Incorporation of the Company
and you found out that they were authorized to issue 1,000,000, P10 par value ordinary
shares and 500,000, 10% P100 par value cumulative preference shares. You extracted
the following Shareholders’ Equity balances as at 31 December 2019. Tax rate applicable
during the year is 30%.

Ordinary Shares, issued (500,000 shares) P 5,000,000

Preference Shares (25,000) P 2,500,000
Share Premium P 10,250,000
Retained Earnings P 5,250,000
Treasury shares, common (15,000 at cost) (P 300,000)
Total Shareholders’ Equity P 22,700,000

During 2020, the following transactions occurred:

Jan. 1 Issued 30,000 ordinary shares in exchange for land with an appraised value of
P1,500,000, assessed value of P1,200,000 and zonal value of P1,350,000.
Another 10,000 shares were also issued to JDV for his legal services. JDV
normally bills his clients for the services rendered at P600,000 but JDV and
COVID-19 Inc’s BOD agreed that the services should be valued at P420,000.

Jan. 2 The Company granted share options to each of its 10 executives. The share
options will vest at the end of year 3, provided that the employees remain in the
entity’s employ, and provided that the volume of sales of a particular product
increases by at least an average of 5 percent per year. If the volume of sales of
the product increases by an average of between 5 percent and 10 percent per
year, each employee will receive 500 share options. If the volume of sales
increases by an average of between 11 percent and 15 percent each year, each
employee will receive 1,000 share options. If the volume of sales increases by
an average of 16 percent or more, each employee will receive 2,000 share
options. On grant date, the Company estimates that the share options have a fair
value of P20 per option. The option holder can exercise buy the shares at P130
Average market price of COVID-19’s share is P500.

Jan. 3 The Company issued 1,000 convertible bonds with face amount of P1,000 and
nominal rate of 8% with interest payable annually. The bonds will mature on 2
January 2025. Each bond is convertible to 50 ordinary shares. Effective interest
rate for this type of bond is 6% with conversion privilege and 12% without
conversion privilege. The bonds were accounted for using the amortized cost
model. The holder has an option to convert these bonds until 31 December 2021.

3|Page jsabellar/rcsoriano
AUDITING
Feb. 2 Issued 60,000 preference shares at a price of P150 per share, and the company
paid P450,000 to an agent for selling the shares.

Mar. 5 Sold 18,000 ordinary shares for P390 per share. Issue costs were P150,000.

Apr. 10 24,000 ordinary shares were sold under share subscriptions at P450 per share.
No shares are issued until a subscription contract is paid in full. No cash was
received.

July 1 60% of the convertible bonds were converted to ordinary shares on this date.

July 14 Exchanged 15,000 ordinary shares and 10,000 preference shares for a building
with a fair value of P5,000,000. The building was originally purchased for
P2,280,000 by the investors and has a book value of P1,320,000. On the same
day COVID-19 issued 5,000 ordinary for P2,000,000 in cash.

Aug. 3 Received payments in full for half of the share subscriptions and payments on
account on the rest of the subscriptions. Total cash received was P8,400,000.
Share certificates were issued for the subscriptions paid in full. The remaining
receivables are collectible in 2021.

Nov. 2 Issued 5,000 ordinary shares for an outstanding bank loan of P2,100,000,
including accrued interest of P100,000. COVID 19’s ordinary shares are quoted
at P410 per share on this date.

Nov. 30 One-half of the treasury shares were sold for P30 per share.

Dec. 1 A one-for-two share split on common shares was approved by the Board of
Directors and by the Securities and Exchange Commission. The split is effective
on this date. Also, the split will apply for the share options and convertible bonds

Dec. 31 It was determined that 2 executives left on this date and the entity still expects
that a total of 5 employees will leave by the end of 2022. Product sales have
increased by 12 percent and the entity expects this rate of increase to continue
over the next 2 years. Fair value of options on this date is P15 per share option.

Dec.31 Net income after tax for the year was P10,600,000.

Dec.31 Declared a cash dividend on preference shares and P5 per share on ordinary
shares, payable on February 1 to shareholders of record on January 5.

Based on the preceding information, calculate the balances of each of the following
accounts:

1. Total Preference Shares

a. 8,500,000 b. 9,500,000 c. 11,050,000 d. 11,550,000
2. Total Ordinary Shares
a. 6,250,000 b. 6,100,000 c. 6,370,000 d. 3,970,000
3. Total Share Premium
a. 37,550,000 b. 37,625,000 c. 36,725,000 d. 39,927,066

4|Page jsabellar/rcsoriano
AUDITING
4. Total Legal Capital
a. 15,870,000 b. 6,250,000 c. 17,800,000 d. 15,520,000
5. Dividends attributed to Ordinary shareholders
a. 6,220,000 b. 950,000 c. 3,110,000 d. 6,295,000
6. Dividends attributed to Preference shareholders
a. 6,220,000 b. 950,000 c. 3,110,000 d. 6,295,000
7. Total Contributed Capital
a. 53,154,000 b. 53,145,000 c. 55,797,066 d. 52,995,000
8. Total Shareholders’ Equity
a. 64,252,066 b. 74,125,924 c. 68,845,000 d. 71,125,000
9. How much is the issue price of the bonds?
a. 1,084,247 b. 855,809 c. 1,000,000 d. 1,144,191
10. How much is the equity component on the issuance of the convertible bonds?
a. 168.495 b. 144,191 c. 228,438 d. 0
11. How much is the increase in Shareholders’ Equity as a result of the conversion of
bonds?
a. 312,686 b. 213,485 c. 520,294 d. 701,096
12. Carrying value of the bonds as of 31 December 2020
a. 385,892 b. 351,675 c. 438,985 d. 483,958
13. Earnings per Share
a. 8.26 b. 8.62 c. 8.14 d. 7.73
14. Diluted Earnings per Share
a. 8.26 b. 8.14 c. 7.73 d. 6.69
15. Compensation Expense for 2020 in relation to the Share Options
a. 33,333 b. 23,333 c. 25,000 d. 0

5|Page jsabellar/rcsoriano