Audit of Liabilities 12%, 25 year Bonds Payable, 2011 issue

1/1/2011 CR P1,600,000
PROBLEM I
Treasury Bonds
Dalias Corporation is selling audio and video appliances. The 10/1/2015 CD P216,000
company’s information relates to the obligations of the company as of
March 31, 2015: Bond Premium
1/1/2011 CR P80,000
Notes payable
Dallas has signed several notes with financial institutions. The Bond Interest Expense
maturities of these notes are given below. The total unpaid interest for 1/1/2015 CD P 96,000
all of these notes amounts to P340,000 on March 31, 2015. 7/1/2015 CD 96,000
Due date Amount The bonds were redeemed for permanent cancellation on October 1,
April 31, 2015 P700,000 2015 at 105 plus accrued interest.
July 31, 2015 900,000
February 1, 2016 800,000 QUESTIONS:
April 31, 2016 1,200,000 Based on the above and the result of your audit, answer the following:
June 30, 2016 1,500,000 (Use straight line amortization method)
P5,100,000
Estimated warranties 1. The adjusted balance of bonds payable as of December 31,
Dallas has a one-year product warranty on some selected items. The 2015 is
estimated warranty liability on sales made during the 2013-2014 fiscal a. P1,400,000 c. P1,600,000
year and still outstanding as of March 31, 2014, amounted to P252,000. b. 1,000,000 d. 1,384,000
The warranty costs on sales made from April 1, 2014 to March 31, 2. The unamortized bond premium on December 31, 2015 is
2015, are estimated at P630,000. The actual warranty costs incurred a. P80,000 c. P64,000
during 2014-2015 fiscal year are as follows: b. 56,000 d. 58,800
Warranty claims honored on 3. The total bond interest expense for the year 2015 is
2013-2014 sales P252,000 a. P189,100 c. P182,900
Warranty claims honored on b. 188,800 d. 182,800
2014-2015 sales 285,000 4. The gain or loss on partial bond redemption is
Total P537,000 a. P1,900 loss c. P1,900 gain
Trade payables b. 18,100 loss d. 18,100 gain
Account payable for supplies, goods, and services purchases on open
account amount to P560,000 as of March 31, 2015. PROBLEM III
Dividends On January 1, 2014, Thunder Corporation issued 2,000 of its 5 year,
On March 10,2015, Dallas’ board of directors declared a cash dividend P1,000 face value, 11% bonds dated January 1 at an effective annual
of P0.30 per ordinary share and a 10% ordinary share dividend. Both interest rate (yield) of 9%. Interest is payable each December 31.
dividends were to be distributed on April 5, 2015 to ordinary Thunder uses the effective interest method of amortization. On
shareholders on record at the close of business on March 31, 2015. As December 31, 2015, the 2,000 bonds were extinguished early through
of March 31, 2015, Dallas has 5 million, P2 par value, ordinary shares acquisition in the open market by Thunder for P1,980,000 plus accrued
issued and outstanding. interest.
Bonds payable
Dallas issued P5,000,000, 12% bonds, on October 1,2009 at 96. The On July 1,2014, Thunder issued 5,000 of its 6-year, P1,000 face value,
bonds will mature on October 1, 2019. Interest is paid semi-annually on 10% convertible bonds at par. Interest is payable every June 30 and
October 1 and April 1. Dallas uses the straight line method to amortize December 31. On the date of issue, the prevailing market interest rate
bond discount. for similar debt without the conversion option is 12%. On July 1,2015,
an investor in Thunder’s convertible bonds tendered 1,500 bonds for
Questions: conversion into 15,000 ordinary shares of Thunder, which had a fair
Based on the foregoing information, determine the adjusted balances of value of P105 and a par value of P1 at the date of conversion.
the following as of March 31, 2015:
1. Estimated warranty QUESTIONS:
a. P252,000 c. P630,000 Based on the above and the result of your audit, determine the
b. 345,000 d. 882,000 following: (Round off present value factors to four decimal places.)
2. Unamortized bond discount 1. The issue price of the 2,000 5-year, P1,000 face value bonds
a. P110,000 c. P200,000 on January 1, 2014 is
b. 100,000 d. 90,000 a. P2,155,534 c. P2,000,000
3. Bond interest payable b. 1,844,434 d. 2,147,800
a. P 0 c. P150,000 2. The carrying amount of the 2,000 5-year, P1,000 face value
b. 300,000 d. 250,000 bonds on December 31, 2014 is
4. Total current liabilities a. P1,898,434 c. P2,000,000
a. P6,445,000 c. P5,445,000 b. 2,129,534 d. 2,121,100
b. 5,105,000 d. 3,945,000 3. The gain on early retirement of bonds on December 31, 2015
5. Total noncurrent liabilities is
a. P7,700,000 c. P7,590,000 a. P20,000 c. P121,286
b. 7,500,000 d. 7,610,000 b. 112,000 d. 0
4. The issuance of the 6-year, P1,000 face value bonds on July
PROBLEM II 1,2014 increased equity by
In your initial audit of Bulls Co., you find the following ledger account a. P419,050 c. P371,050
balances. b. 411,300 d. 0
5. The conversion of the 1,500 6-year, P1,000 face value bonds
on July 1, 2015 increased share premium by
a. P1,485,000 c. P1,415,054

Review: Auditing Page 1

 b. 1,374,000 d. 1,377,697 5. Magic commenced litigation against one of its adverse for
negligent advise given on the original installation of the conveyers
PROBLEM IV belt referred to in (4) above. In October 2015 the court found in
Relevant extracts from Magic Corporation’s financial statements at 31 favor of Magic. The hearing for damages had not been scheduled
December 2014 are as follows: as at the date the financial statements for 2015 were authorized for
Current liabilities issue. Magic estimated that it would receive about P500,000.
Provision for warranties P405,000 6. Magic signed an agreement with Choko Bank to the effect that
Magic would guarantee a loan made by Choko Bank to Magic’s
Non-current liabilities subsidiary, UN Ltd. UN’s Ltd. loan with Choko Bank was
Provision for warranties 270,000 P3,000,000 as at 31 December 2015. UN Ltd. was in a strong
financial position at 31 December 2015.
Note 10- Contingent liabilities
Magic is engaged in litigation with various parties in relation to allergic QUESTIONS:
reactions to traces of peanuts alleged to have been found in packets of Based on the above and the result of your audit, answer the following:
fruit gums. Magic strenuously denies the allegations and, as at the date 1. The warranty expense in 2015 is
of authorizing the financial statements for issue, is unable to estimate a. P150,000 c. P600,000
the financial effect, if any, of any costs or damages that may be payable b. 240,000 d. 345,000
to the plaintiff. 2. The provision for warranties as of December 31,2015 is
a. P870,000 c. P345,000
The provision for warranties at 31 December 2014 was calculated using b. 720,000 d. 615,000
the following assumptions. There was no balance carried forward from 3. The provision for warranties to reported as current liability as
the prior year: of December 31,2015 is
Estimated costs of repairs- products a. P330,000 c. P225,000
With minor defects P1,500,000 b. 600,000 d. 495,000
Estimated costs of repairs- products 4. The provision for warranties to reported as noncurrent
With major defects 9,000,000 liability as of December 31,2015 is
Expected % of products sold during 2014 a. P120,000 c. P390,000
Having no defects in 2015 80% b. 225,000 d. 495,000
Expected % of products sold during 2014 5. Total provisions to be reported in the statement of financial
Having minor defects in 2015 15% position as of December 31,2015 is
Expected % of products sold during 2014 a. P720,000 c. P615,000
Having minor defects in 2015 5% b. 1,770,000 d. 2,040,000
Expected timing of settlement of warranty
Payments- those with minor defects All in 2015 PROBLEM V
Expected timing of settlement of warranty Jackie Corporation has entered into an agreement to lease a machine to
Payments- those with major defects 40% in 2015, a Lessee Corporation. The lease agreement details are as follows:
60% in 2016 Length of lease 5 years
Commencement date January 2015
During the year ended 31 December 2015 the following occurred: Annual lease payment payable 31
1. In relation to the warranty provision of P675,000 at 31 December December each year commencing
2014, P300,000 was paid out of the provision. Of the amount paid, 31 December 2015 P8,000
P225,000 was for products with minor defects and P75,000 was for Fair value of the machine at 1
products with major defects, all of which related to amounts that January 2015 P34,797
had been expected to be paid in 2015. Estimated economic life of the machine 8 years
2. In calculating its warranty provision for 31 December 2015, Magic Estimated residual value of the asset
made the following adjustments to the assumptions used for the at the end of its economic life P2,000
prior year: Residual value of the asset at the end
Estimated cost of repairs- products of the lease term, of which 50% is
with minor defects No change guaranteed by Lessee Corporation P7,200
Estimated cost of repairs- products interest rate implicit in the lease ?
with major defects P7,500,000 The lease is cancellable, but a penalty equal to 50% of the total lease
Estimated % of products sold during payments on cancellation. Lessee Corporation does not intend to buy
2015 having no defects in 2016 85% the machine at the end of the lease term, Jackie Corporation incurred
Expected % of products sold during P1,000 to negotiate and execute the lease agreement. Jackie Corporation
2015 having minor defects in 2016 13% purchased the machine for P34,797 just before the inception of the
Expected % of products sold during lease.
2015 having major defects in 2016 2%
Expected timing of settlement of QUESTIONS:
warranty payments- those with Based on the above and the result of your audit, answer the following:
minor defects All in 2016 (Round off present value factors to four decimal places)
Expected timing of settlement of 1. The interest rate implicit in the lease is
warranty payments- those with a. 6% c. 8%
major defects 20% in 2016, b. 7% d. 9%
80% in 2017 2. Ignoring income taxes, if Jackie Corporation erroneously
3. Magic determined that part of its plant and equipment needed an accounted for the transaction as an operating lease, its profit
overhaul- the conveyer belt on one of its machines would need to for 2015 will be overstated by
be replaced in about December 2016 at an estimated cost of a. P478 c. P 678
P500,000. The carrying amount of the conveyer belt at 31 b. 553 d. 6,223
December 2014 was P280,000. Its original cost was P400,000. 3. The amount to be reported by Lessee Corporation under
4. Magic was unsuccessful in its defense of the peanut allergy case current liabilities as liability under finance lease as of 31
and was ordered to pay P2,000,000 to the plaintiffs. As at 31 December 2015 is
December 2015 Magic had paid P1,500,000. a. P5,208 c. P5,709

Review: Auditing Page 2

 b. 5,438 d. 6,291
4. The depreciation amount to be recognized by Lessee
Corporation for the year ended 31 December 2015 is
a. P5,971 c. P3,932
b. 5,251 d. 6,291
5. Ignoring income taxes, if Lessee Corporation erroneously
accounted for the transaction as an operating lease, its profit
for 2015 will be overstated by
a. P1,513 c. P1,193
b. 1,302 d. 982

Review: Auditing Page 3