Auditing Problems-Review

AUDIT OF SHAREHOLDERS EQUITY REVIEW PROBLEMS

Problem 1
PABEBE CO. was formed on July 1, 2013. It was authorized to issue 1,800,000 shares of 10 par value ordinary
shares and 600,000 shares of 8% P25 par value, cumulative and nonparticipating preference shares . PABEBE CO.
has a July 1- June 30 fiscal year.

The following information relates to the shareholders equity accounts of PABEBE CO.:

Ordinary Shares
Prior to the 2015-2016 fiscal year, PABEBE CO. had 660,000 ordinary shares issued as follows:
1. 510,000 shares were issued for cash on July 1, 2013, at P31 per share
2. On July 24, 2013, 30,000 shares exchange for a plot of land which cost the seller P420,000 in 2007 and
had an estimated market value of P1,320,000 on July 24, 2013.
3. 120,000 shares were issued on March 1, 2014, for P42 per share.

During the 2015-2016 fiscal year, the following transactions regarding ordinary shares took place:

November 30, 2015 PABEBE CO. purchased 12,000 of its own shares on the open market at P39 per share

December 15, 2015 PABEBE CO. declared a 5% stock dividends for shareholders of record on January 15,
2016, to be issued on January 31, 2016. PABEBE CO. was having a liquidity problem and
could not afford a cash dividend at that time. PABEBE CO.s ordinary shares were selling
at P52 per share on December 15, 2015

June 20, 2016 PABEBE CO. sold 3,000 of its own ordinary shares that it had purchased on November 30,
2015, for P126,000

Preference Shares
PABEBE CO. issued 240,000 preference shares at P44 per share on July 1, 2014

Cash Dividends

PABEBE CO. has followed a schedule of declaring cash dividends in December and June, with payment being made
to the shareholders of record in the following month, The cash dividends which have been declared since
inception of the company through June 30, 2016, are shown below:

Declaration Date Share Capital Ordinary Share Capital Preference

12/15/14 0.3 per share 1 per share
6/15/15 0.3 per share 1 per share
12/15/15 - 1 per share

No cash dividends were declared during June 2016 due to the companys liquidity problems.

Retained Earnings

As of June 30, 2015, PABEBE COs retained earnings account has a balance of P4,140,000. For the fiscal year
ending June 30, 2016, PABEBE CO. reported net income of P240,000.

REQUIRED

Compute the adjusted balances of the following as of June 30, 2016

Share Capital-preference 6,000,000

Share capital-ordinary 6,924,000
Share Premium-preference 4,560,000
Share Premium-ordinary 16,930,000
Share premium-treasury 9,000
Retained earnings (before appropriation for TS) 2,695,200
Treasury shares 351,000
Total shareholders equity 35,867,200
Problem 2

The shareholders equity section of RONLEI CO.s statement of financial position as of December 31, 2015 is as
follows:
Share capital- Ordinary(P10 par, 750,000shares
authorized, 412,500 issued and outstanding) P4,125,000
Share premium 825,000
Total paid-in capital P4,950,000
Unappropriated retained earnings P2,002,500
Appropriated retained earnings 750,000
Total retained earnings 2,752,500
Total shareholders equity P7,702,500

RONLEI CO. had the following shareholders equity transaction during 2016:

Jan 15 Completed the building renovation for which 750,000 of retained earnings had been restricted. Paid the
contractor P727,500, all of which is capitalized.
Mar 3 Issued 150,000 additional ordinary shares for P18 per share.
May 18 Declared a dividend of 1.5 per share to be paid on July 31, 2016 to shareholders of record on June 30,
2016.
June 19 Approved additional building renovation to be funded internally. The estimated cost of the project is
600,000, and retained earnings are to be restricted for that amount.
Jul 31 Paid the dividends
Nov 12 Declared a property dividend to be paid on January 5, 2017. The dividends is to consist of equipment that
has a carrying amount of 360,000 and a fair value of P472,500 on Nov. 12
Dec 31 Net income for 2016 (before recognition of impairment loss on the equipment declared as property
dividends) is P1,327,500. The equipments fair value less cost of to distribute on December 31 is P330,000

1. Share capital-ordinary on December 31, 2016, is

a. 5,625,000 b. 4,125,000 c. 4,950,000 d. 7,650,000

2. Share premium on December 31, 2016, is

a. 2,625,000 b. 825,000 c. 2,025,000 d. 1,200,000

3. Unappropriated retained earnings on December 31, 2016, is

a. 2,163,750 b. 2,246,250 c. 2,133,750 d. 2,276,250

4. The total shareholders equity on December 31, 2016, is

a. 10,376,250 b. 10,526,250 c. 9,926,250 d. 7,650,000

Problem 3

At the beginning of year 1, Entity A grants share option to each of its 100 employees working in the sales
department. The share option will vest at the end of year 3, provided that the employees remain in the entitys
employ, and provide that the volume of sales of the product increases by an average of between 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 100 share options. If the volume of sales increases by an average of between 11 and
15 percent each year, each employee will receive 200 share options. If the volume of sales increases by an
average of 16% or more, each employee will receive 300 share options.

On grant date, Entity A estimates that the share options have a fair value of 20 per option. Entity A also estimates
that the volume of sales of the product will increase by an average of between 11 percent and 15 percent per
year, and therefore expects that, for each employee who remains in service until end of year 3, 200 share options
will vest. The entity also estimates, on the basis of a weighted average probability, that 20 percent of employees
will leave before the end of year 3.

By the end of year 1, seven employees have left and the entity still expects that a total of 20 employees will leave
by the end of year 3. Hence, the entity expects that 80 employees will remain in service for the three year period.
Product sales have increased by 12 percent and the entity expects this rate of increase to continue over the next 2
years.

By the end of year 2, a further five employees have left, bringing the total to 12 to date. The entity now expects
only three more employees will leave during year 3, and therefore expects a total of 85 employees will remain at
the end of year 3. Product sales have increased by 20 percent, resulting in an average of 16% over the two years
to date. The entity now expects that the sales will average 16% or more over the 3-year period, and hence expects
each sales employee to receive 300 share options at the end of year 3.

By the end of year 3, a further two employees have left. Hence, 14 employees have left during the 3-year period,
and 86 employees remain. The entitys sales have increased by an average of 16% over the three years.

Based on the preceding information, answer the following:

1. What is the compensation expense for year 1?106,667

2. What is the compensation expense for year 2?233,333
3. What is the compensation expense for year 3?176,000
4. What is the cumulative compensation expense for years 1,2, and 3?516,000
5. At the end of year 2, the entity should report share option outstanding of---- 340,000

Problem 4

An entity grants 100 cash share appreciation rights (SARs) to each of its 500 employees, on condition that the
employees remain in its employ for the next year.

During year 1, 35 employees have left. The entity estimates that a further 60 will leave during years 2 and 3.
During year 2, 40 employees have left and the entity estimates that a further 25 will leave during year 3. During
year 3, 22 employees have left. At the end of year 3, 150 employees exercised their SARs, another 140 employees
exercised their SARs at the end of year 4 and the remaining 113 employees exercised their SARs at the end of year
5.

The entity estimates the fair value of the SARs at the end of each year in which a liability exists as shown below. At
the end of year 3, all SARs held by the remaining employees vested. The intrinsic value of the SARs at the date of
exercise (which equal the cash paid out) at the end of years 3, 4 and 5 are also shown below.

Year Fair Value Intrinsic Value

1 14.4 -
2 15.5 -
3 18.2 15
4 21.4 20
5 - 25

Compute the amount of compensation expense and liability that the entity should report in years 1 to 5.

THEORIES

1. In an examination of shareholders equity, an auditor is most concerned that

a. Capital stack transactions are properly authorized
b. Stock splits are capitalized at par or stated value on the dividend declaration date
c. Dividends during the year under audit were approved by the shareholders
d. Changes in the accounts are verified by a bank serving as a registrar and stock transfer agent

2. When a corporate client maintains its own stock records, the auditor primarily will rely upon
a. Confirmation with the company secretary of shares outstanding at year end
b. Review of the corporate minutes for data as to shares outstanding
c. Confirmation of the number of shares outstanding at year end with the appropriate state official
d. Inspection of the stock book at year-end and accounting for all certificate number

3. An audit program for the retained earnings account should include a step that requires verification of the
a. Fair value used to charge retained earnings to account for a 2 for 1 stock split
b. Approval of the adjustments to the beginning balance as a result o a write-down of an A/R
c. Authorization for both cash and stock dividends.
d. Gain or loss arising from disposition of treasury shares.

4. If the auditee has a material amount of treasury stock on hand at year end, the auditor should
a. Count the certificates at the same time other securities are counted
b. Count the certificates only if the company had treasury stock transaction during the year
c. Not count the certificates if treasury stocks is a deduction from shareholders equity
d. Count the certificates only if the company classifies treasury stock with other assets