The following are assertions about account balances

at the period end except:

A. Existence
B. Rights and obligations
C. Valuation and allocation
D. Cutoff

Answer: D
The cutoff assertion deals with whether
transactions and events have been recorded in the
correct accounting period
On December 31, 20X6, DAY1 Co. shipped to a customer merchandise
with selling price of P37,500; terms net 30, FOB shipping point. The sale
which is 125% of cost was recorded in January 20X7 when the check
was received from the customer. Ending inventory was determined by
physical count on December 31, 20X6.

As a result of the above transactions, DAY1 Co.’s cost of goods sold for
the year ended December 31, 20X6 was:

A. Understated by P30,000
B. Overstated by P30,000
C. Overstated by P37,500
D. Correctly stated

Answer: D
Since ending inventory has been determined through physical
count, the goods in transit would not be included and cost of goods
sold would be correctly stated.
In a well-designed internal control system, employees in the
same department most likely would approve purchase order
and also:

A. Negotiate terms with vendors.

B. Authorize requisition of goods.
C. Inspect and count goods upon receipt
D. Reconcile the open invoice file

Answer: A
B,C, and D are functions incompatible with the
authorization performed by purchasing department.
The following information is from ABC Co.’s first year of operations:

Merchandised purchased, P450,000

Ending merchandise inventory, P123,000
Collections from customers, P150,000
All sales are on account and good sell at 30% above cost.

What is the accounts receivable balance at the end of the company’s

first year of operations?

Answer: P 275,100
Purchases P450,000
Merchandise inventory, ending (123,000)
Cost of goods sold 327,000
Multiply by sales ratio 130%
Sales 425,100
Collections from customers 150,000
Accounts receivable, ending P275,100
An objective of a walk-through is to:

A. Replace tests of controls

B. Identify weaknesses to be communicated to management in
the management letter
C. Evaluate the major strengths and weaknesses in the client's
structure
D. Verify that the structure has been placed in operation

Answer: D
A walk-through test is one of many tests performed by
auditors during their evaluation of a company's controls
and risk management measures. A walk-through test is a
procedure used during an audit of an entity's accounting
system to measure its reliability. Walk-though tests trace
the transaction step-by-step through the accounting system
from its inception to the final disposition
JESS Company’s December 31, 20X6 audited statement of
financial position reported retained earnings of P150,000. Net
income for 2014 was P85,000 and dividends of P60,000 were
declared and paid in 2014. ABC Company’s accountant
discovered that net income for 20X5 had been understated by
P25,000 due to error in recording depreciation expense in 20X5.
The amount of retained earnings per books as of December 31,
20X5 amounted to?

Answer: P100,000
Retained earnings per book, December 31, 20X5 (Squeeze) P100,000

Adjustment for depreciation error in 20X5 25,000

Retained earnings as adjusted, December 31, 20X5 125,000

Net income in 20X6 85,000

Dividends declared and paid in 20X6 (60,000)

Retained earnings per audit, December 31, 20X6 P150,000

For initial audit engagements, the auditor should obtain
sufficient appropriate audit evidence that:

A. The opening balances do not contain misstatements that

materially affect the current period's financial statements.
B. The prior period's closing balances have been correctly
brought forward to the current period or, when appropriate,
have been restated.
C. Appropriate accounting policies are consistently applied or
changes in accounting policies have been properly accounted
for and adequately disclosed.
D. All of the above

Answer: D
Refer to PSA 510
The letter of audit inquiry should be:

A. Prepared and sent by the auditor

B. Prepared by the management and sent by the auditor
C. Prepared and sent by management
D. Prepared by the auditor and sent by management

Answer: B
The letter of audit inquiry, which should be prepared by
management and sent by the auditor, requests the entity’s
legal counsel
Which of the following is the correct order of steps in the audit
process?

I. Perform tests of control

II. Develop an overall strategy for the expected conduct and
scope of audit
III. Obtain client’s written representation
IV. Prepare engagement letter
V. Perform substantive tests

A. IV, I, II, V, III

B. IV, II, I, V, III
C. IV, II, III, I, V
D. IV, II, V, I, III

Answer: B
Tobruk Company has an agreement to pay its sales manager a
bonus of 5% of the income after bonus and after tax. The
income for the year before bonus and tax is P5,250,000. The
income tax rate is 30% of income after bonus. What is the
bonus for the year?

Answer: 177,536
B = .05 (5,250,000 – B – T)
T = .30(5,250,000 – B)
B = .05[5,250,000 – B - .30(5,250,000 –
B)]
B = .05(5,250,000 – B – 1,575,000 + .30B)
B = 262,500 - .05B – 78,750 + .015B
B + .05B - .015B = 262,500 – 78,750
1.035B = 183,750
B = 183,750 / 1.035
B = 177,536
Which of the following most likely would not be
considered an inherent limitation of internal control?

A. Collusion among employees

B. Mistakes in judgment
C. Incompatible functions
D. Management override

Answer: C
The performance of incompatible functions is not
an inherent limitation of internal control but a
failure to segregate functional responsibilities
properly.
Problems Co. reported depreciation of P2,500,000 in
its 2011 tax return. However, in its 2011 income
statement, Problems Co. reported depreciation of
P1,000,000. The difference in depreciation is
temporary difference that will reverse over the time.
The tax rate is constant at 30%. What amount should
be added to the deferred tax liability in Problems
Company’s December 31, 2011 statement of financial
position?

Answer: P450,000
1,500,000 x 30%= P450,000
Bonus Company gives bonus to his employees. The
total percent for bonus of the all employees is 10%.
The bonus is computed as percent of income after
bonus and tax. The tax rate is 25%. The net income
bonus and tax is P1,245,000. Manong is an employee
of Bonus company and his share in total bonus of all
employees is 35%. What is the share of Manong in
bonus? No decimal places.

Answer: P30,401
Bonus = 10%(1,245,000 – B – 25%(1,245,000 – B)
= 124,500 – 10%B – 31,125 + 2.5%B
=93,375-7.5%
100 + 7.5% = 93,375
107.5%B = P93,375
B = 86,860
Multiply by 35% = 30,401
Which of the following statements is true?

A. The controller performs primarily a line function

B. The treasurer performs primarily a line function
C. The primary functions of a controller are basically
the same as those of a treasurer
D. Managers with staff functions are directly involved
in the provision of goods and services

Answer: B
The controller performs a staff function; the
treasurer and the controller do not have the same
function; Managers with staff functions are
indirectly involved in the provision of goods and
services.
Palawan Company has determined that its electronics division is a cash generating unit.
The entity calculated the value in use of the division to be P8,000,000. The assets of the
cash generating unit at carrying amount are as follows:

Building 5,000,000
Equipment 3,000,000
Inventory 2,000,000

Palawan company has also determined that the fair value less cost to sell of the building
is P4,500,000. What is the impairment loss to be allocated to the equipment?

Answer: P900,000

Total Book Value of CGU 10,000,000

Value in Use 8,000,000
Impairment 2,000,000
Impairment for Building (500,000)
Impairment for Equipment and Inventory 1,500,000
For Equipment 1,500,000 x 3/5 P900,000
The following are purposes of analytical procedures, except:

A. Assist the auditor in planning the nature, timing and extent of other audit
procedures
B. As a test to obtain audit evidence about the suitability of design and effective
operation of internal controls
C. As a substantive procedure when their use can be more effective or efficient
than tests of details in reducing detection risk for specific financial statement
assertions
D. As an overall review of the financial statements in the final review stage of
the audit

Answer: B
Test to obtain audit evidence about the suitability of design and effective operation
of internal controls is for test of controls.
On June 2, 2013, Problems Company sold merchandise with an invoice price of
P960,000 to NoProblem Company, a customer.. The entity allowed trade
discounts of 20% and 10%. Credit terms were 5/10, n/30 and the sale was
made FOB shipping point. The Problems Company paid P50,300 for delivery
cost.

On June 10, the costumer paid all his liabilities to Problems Company as a
result of purchase on June 2. How much is the cash received by Problems
Company on June 10?

Answer: P962,300
Invoice price 960,000*95% =912,000 + 50,300
Which of the following statements is correct with respect to an auditor’s report
expressing an opinion on a specific item on a financial statement?

A. Materiality must be related to the specified item rather than to the financial
statement taken as a whole.
B. Such a report can only be issued if the auditor is also engaged to audit the entire
set of financial statement.
C. The attention devoted to the specified item usually less than it would be if the
financial statements as a whole were being audited.
D. The auditor who has expressed an adverse opinion on the financial statements as
a whole can never express an opinion on a specified item in these financial
statements

Answer: A
Problems Company discounted its 1 year note receivable to NoProblem
Company on July 1, 2014. The note was received on May 1, 2014 by Problem
Company. The Problem company received P980,000 from discounting. The
discount rate is 15% while the stated rate on the note is 12%. The loss on
discounting is recorded by P40,000. What is the face value of the note?

ANSWER: P1,020,000
Entry:
Cash 980,000
Loss on discounting 40,000
Note receivable and interest 1,020,000

#1,020,000 divided by 102%

#102% = 100% + (12% x 2/12)
Which of the following best describes assurance services?

A. Independent professional services that are intended to enhance the

credibility of information to meet the needs of an intended user
B. Services designed to express an opinion on the fairness of historical financial
statements based on the results of an audit
C. The preparation of financial statements or the collection, classification, and
summarization of other financial information.
D. Services designed for the improvement of operations, resulting in better
outcomes.

Answer: A
Assurance service is independent professional services that are intended to
enhance the credibility of information to meet the needs of an intended user.
An auditor concludes that there is material inconsistency in the other information in an
annual report to shareholders containing audited financial statements. The auditor believes
that the financial statements do not require revision, but the client is unwilling to revise or
eliminate the material inconsistency in the other information. Under these circumstances,
what action would the auditor most likely take?

A. Consider the situation closed because the other information is not in the financial
statements.
B. Issue and “except for” qualified opinion after discussing the matter with the clients audit
committee.
C. Disclaim an opinion on the financial statements after explaining the material
inconsistency in a separate “other matter” paragraph.
D. Revise the auditor’s report to include a separate “other matter” paragraph describing the
material inconsistency.

Answer: D
Since there is material inconsistency in the other information and the client is
unwilling to revise the audited financial statement, per PSA706 – “Emphasis of Matter
paragraphs and Other Matter Paragraphs in the Independent Auditors Report”, if the
auditor considers it necessary to communicate a matter other than those that are
presented or disclosed in the financial statements that, in the auditor’s judgment, is
relevant to users’ understanding of the audit, the auditor’s responsibilities or the
auditor’s report and this is not prohibited by law or regulation, the auditor shall do so
in a paragraph in the auditor’s report, with the heading “Other Matter,” or other
appropriate heading. The auditor shall include this paragraph immediately after the
Opinion paragraph and any Emphasis of Matter paragraph, or elsewhere in the
auditor’s report if the content of the Other Matter paragraph is relevant to the Other
Reporting Responsibilities section. (Ref: Para. A5-A11)
On January 1, 20X6, Jason Company issued P5 million of 10-year bonds at a 10%
stated interest rate to be paid annually. The following present value factors have
been provided to answer the subsequent questions.

Time period Interest PV of P PV of an Annuity

10 10% .386 6.145
10 8% .463 6.710
10 12% .322 5.650

Calculate the issuance price if the market rate of interest is 12%.

Answer: P4,435,000

Principal x PV Factor of P, 12% 10years

5,000,000 x .386 1,610,000
Interest x PV Factor of an Annuity, 12% 10 years
(5,000,000 x 10%) x 5.650 2,825,000
4,435,000
The ABC Company had weak internal controls over cash transactions. Facts about its cash position at
November 30, 20X6 were as follows:

The cash book showed a balance of P94,508 which included undeposited receipts. A credit of P500 on
the bank’s records did not appear on the books of the company. The balance per bank statement was
P77,750. Outstanding checks were no. 8420 for P581, no. 8422 for P750, no. 8430 for P1,266, no.8621
for P954, no. 8623 for P1,034 and no. 8632 for P726. The cashier stole all undeposited receipts in excess
of P18,972 and prepared the following reconciliation:

How much cash was stolen by the cashier? ANSWER: A

A. P3,597
B. P3,097 Cash balance per books, P94,508
C. P4,097 Add: Bank credit 500
Adjusted cash bank balance (on hand and in bank) 95,008
D. P0 Less: Adjusted bank balance :
Bank balance, November 30 P77,750
Less: Outstanding checks
No. 8420 P581
8422 750
8430 1,266
8621 954
8623 1,034
8632 726 5,311 72,439
Cash that should be on hand for deposit 22,569
Cash reported 18,972
Cash stolen P3,597
GONE Company Uses accrual accounting and has the following information:

Net Sales P1,000,000

COS P500,000
Operating Expense P200,000
Income Tax P87,000

Depreciation is 30% of Gross profit.

What is the depreciation expense if GONE Company uses CASH BASIS

accounting?

Answer: P150,000
Depreciation is not affected.
The physical inventory of STAVES Inc. as of December 26, 20X6 totaled P945,000.
You agreed on the December 26, 20X6 count as the company has a good
internal control system. In trying to establish the December 31 inventory, you
noted the following transactions from the December 27 to December 31, 20X6.

Inventory per count, December 26, 20X6 P945, 000

Add (deduct) transactions, December 27 – 31, 20X6

Cost of goods sold (P390,000 / 130%) (300,000)

Goods returned by customers on December 29 (P15,600 / 130%) 12,000

Goods returned to suppliers on December 28 (6,000)

Purchases placed in stock 90,000

Purchases in transit, FOB shipping point 124,500

Inventory balance, December 31, 20X6 P865,500

What is the inventory balance on December 31, 20X6?

Answer: P865,500
Net income for TECHNICA Company for the calendar year 20X5 and 20X6 is shown below.
A review of the accounts disclosed the following errors
20X5 20X6
Net income per books 75,600 96,900
Errors disclosed:
Equipment purchased at year-end charged to expense
(with estimated 10-year life) 10,000
Increase of Reserve for Contingencies charged to
Operations 12,000
Overstatement of inventory at year-end 3,000
Goods purchased not recorded as liability and not included
in inventory 4,000
Rent received in advance 1,500
Unpaid salaries not taken up in the books 900
Insurance premium on one-year fire policy taken and paid
on May 1, 20X6, all charged to expense 1,200

The correct net income for 20X6 is

Answer: P113,700
Net Income per books 96,900
Depreciation (1,000)
Reserve for Contingencies 12,000
Overstatement of inv. 3,000
Unearned Rent 1,500
Unpaid salaries 900
Insurance expense 400
113,700
AGAPE Corporation must determine the December 31, 20X5 year-end accruals for
advertising and rent expenses. A P50,000 advertising and rent expenses. A P50,000
advertising bill was received on January 10, 20X6 comprising costs of P37,500 for
advertisements in December 20X5 issues, and P12,500 for advertisements in January 20X6
issues of newspaper.

A store lease, effective December 16, 20X4, calls for fixed rent of P120,000 per month,
payable one month from the effective date and monthly thereafter. In addition, rent equal
to 5% of net sales over P6,000,000 per calendar year is payable on January 31 of the
following year. Net sales of 20X5 amounted to P7,500,000.

What is the total accrued liability that should be reported by ABC Corporation on its
statement of financial position as at December 31, 20X5?
Answer: P172,500
Advertising P37,500

Fixed rent, December 16 – 31 (P120,000 x ½) 60,000

Variable rent (P7,500,000 – P6,000,000 = P1,500,000 x 5%) 75,000

Total P172,500
When assessing the tolerable rate, the auditor should consider that, while deviations from control
procedures increase the risk of material misstatements, such deviations do not necessarily result in
errors. This explains why

A. A recorded disbursement that does not show evidence of required approval may nevertheless be a
transaction that is properly authorized and recorded.
B. Deviations would result in errors in the accounting records only if the deviations and the errors
occurred on different transactions.
C. Deviations from pertinent control procedures at a given rate ordinarily would be expected to result in
errors at a higher rate.
D. A recorded disbursement that is properly authorized may nevertheless be a transaction that contains
a material error.

Answer: A
The requirement is to determine why deviations from control procedures do not necessarily result
in errors. Answer (a) is correct because it provides an example of a situation in which a deviation
from a control procedure exists (lack of documentation of transaction approval), although the
entry was authorized and proper. Thus, such a deviation does not necessarily result in an error in
the financial statements. Answer (b) is incorrect because a deviation from control procedure and
an error may occur in the same transaction. Answer (c) is incorrect since the fact that all
deviations do not lead to errors will result in a lower error rate. Answer (d) is incorrect because
while it represents a correct statement, it does not follow from the point of the question which is
based on the idea that deviations do not directly result in errors.
On January 1, 20X6, Lena Corporation decided to dispose of an item of plant that is
carried in its records at a cost of P900,000, with accumulated depreciation of P160,000.
Depreciation on the plant since it was originally acquired has been charged of P10,000
per month. The plant will continue to be operated until it is sold, at which time the
operations of the plant will be outsourced. The company undertook all the necessary
actions to be able to classify the asset as held for sale. It is estimated that it could sell
the plant for its fair value, P720,000, incurring P20,000 selling costs in the process. The
plant has been depreciated at an amount of P10,000 per month.

On March 31, 20X6, the plant had not been sold but, due to shortage of this type of
plant, there had been an increase in the fair value to P770,000. On June 30, 20X6, Lena
sold the plant for P785,000 incurring P25,000 selling costs.

The depreciation expense to be recognized in 2016 is

Answer: P0
Depreciation ceased when classified as noncurrent asset held for sale.
HOWARD Corp. uses Machine A in its manufacturing process. It acquired this machine
from manufacturers. The following information relates to Machine A that it has
recorded in 20X6.

Machine A, purchased
Cost paid for equipment P250,000
Cost of transporting machine – insurance and transport 9,000
Labor cost of installation by expert filter 15,000
Labor cost of testing equipment 12,000
Insurance cost of 20X2 4,500
Cost of training for personnel who will use the machine 7,500
Cost of safety rails and platforms surrounding machine 18,000
Cost of water devices to keep machine cool 24,000
Cost of adjustments to machine during 20X2 to make it operate more efficiently
22,500

What is the cost of Machine A?

Answer: P350,500 Machine A
Cost paid for equipment P250,000
Cost of transporting machine – insurance and transport 9,000
Labor cost of installation by expert filter 15,000
Labor cost of testing equipment 12,000
Cost of safety rails and platforms surrounding machine 18,000
Cost of water devices to keep machine cool 24,000
Cost of adjustments to machine during 20X2 to make it operate 22,500
more efficiently
Total costs P350,500
Which of the following procedures are performed by an auditor who
wants to detect material misstatements at the assertion level?

A. Substantive tests
B. Test of control
C. Compliance tests
D. Dual-purpose tests

Answer: A
Substantive tests are procedures performed in order to detect
material misstatements at the assertion level, including test of
details of account balances, classes of transactions and disclosures,
and substantive analytical procedures.
You were able to extract the following information from the records of
Black Corporation in connection with the audit of Black’s financial
statements for the year ended
December 31, 2013:
Carrying Amount Tax Base
Accounts receivable 1,500,000 1,750,000
Motor vehicles 1,950,000 1,150,000
Provision for warranty 120,000 0
Deposits received in advance 150,000 0

-The company uses straight-line method of depreciation for financial reporting purposes and SYD method for
income tax purposes
-Deposits are taxable when received and warranty costs are deductible when paid.
-An allowance for doubtful accounts of 250,000 has been raised against accounts receivable for accounting
purposes, but such accounts are deductible only when written off as uncollectible.
-Taxable income in 2013 amounted to 1,000,000 while income tax paid for the first three quarters amounted to
175,000.

Compute the amount of taxable temporary difference

ANSWER: 800,000
Carrying amount of motor vehicle 1,950,000
Tax base 1,150,000
Taxable temporary difference 800,000
On June 30, 2015, th eApolinario Copper Mines, Inc. purchased a copper mine for P14,580,000.
The estimated capacity of the mine was 1,620,000 tons. Apolinario Copper Mines expects to
extract 25,000 tons of ore a month with an estimated selling price of P50 per ton. Production
started immediately after some new machines costing P1,800,000 were bought on June 30,
2015. These new machines had an estimated useful life of 15 years with a scrap value of 10%
of cost after the ore estimate has been extracted from the property, at which time the machines
will already be useless. Apolinario’s books show the following expenses for 2015:

Depletion expense P1,215,000

Depreciation—Machinery 120,000

Recorded depletion expense was

A. Overstated by P270,000.
B. Understated by P135,000.
C. Overstated by P405,000.
D. Understated by P405,000.

ANSWER: B
Solution:
Depletion rate per ton (P14,580,000 / 1,620,000) P9
Copper ore mined in 2015 (15,000 x 6 months) x 150,000
Depletion for 2015 P 1350,000
Depletion per books
1,215,000
Overstatement of depletion expense P135,000
The December 31 year-end financial statements of Sandra Company contained the following
errors:
Dec. 31, 2014 Dec. 31, 2015
Ending inventory P48,000 understated P50,500 overstated
Depreciation expense P12,500 understated -------

An insurance premium of P330,000 was prepaid in 2014 covering the years 2014, 2015, and
2016. The entire amount was charged to expense in 2014. In addition, on December 31, 2015,
a fully depreciated machinery was sold for P75,000 cash, but the sale was not recorded until
2016. There were no other errors during 2014 and 2015, and no corrections have been made
for any of the errors. Ignore income tax effects.

What is the total effect of the errors on the balance of Sandra’s retained earnings at December
31, 2015?
Answer: P122,000 understatement
Solution:
Over- (Under-)statement
Overstatement of 2015 ending inventory P 50,500
Understatement of depreciation expense in 2014 12,500
Prepaid insurance charged to expense in 2014 (110,000)
Unrecorded sale of fully depreciated machinery in 2015 (75,000)
Total effect on retained earnings (P122,000)
Idora Company sells its products in expensive, reusable containers. The customer is charged a
deposit for each container delivered and receives a refund for each container returned within
two years after the year of delivery. Idora accounts for the containers not returned within the
time limit as being sold at the deposit amount. Information for 2015 is as follows:

Containers held by customers at

December 31, 2014,
from deliveries in:2013 95,000
2014 260,000 355,000
Containers delivered in 2015 450,000
Containers returned in 2015
from deliveries in:2013 57,500
2014 140,000
2015 157,000 354,500

What is the total amount of Idora Company’s liability for returnable containers at December
31, 2015?

Answer: P423,000
Liability for returnable containers, Dec. 31, 2014 P355,000
Deliveries in 2015 450,000
Total 805,000
2015 container returns P354,500
2015 container sales 27,500 (382,000)
Liability for returnable containers P423,000
Which of the following substantive procedure that an auditor would most
likely perform to verify the existence and valuation of recorded accounts
payable?

A. Vouching selected entries in the accounts payable subsidiary ledger to

purchase orders and receiving reports.
B. Confirming accounts payable balances with known suppliers who have
zero balances.
C. Investigating the open purchase order file to ascertain that pre-
numbered purchase orders are used and accounted for.
D. Receiving the client’s mail, unopened, for a reasonable period of time
after year-end to search for unrecorded vendor’s invoice.
Answer: A
Vouching a sample of entries in the accounts payable subsidiary ledger to purchase
orders and receiving reports provides audit evidence about whether recorded liabilities
exist at a given date and are reported at appropriate amounts.
In a well-designed internal control, the same employee may be
permitted to

A. Prepare receiving reports and also approve purchase orders.

B. Mail signed checks and also cancel supporting documents
C. Mail signed checks and also prepare bank reconciliations
D. Approve vouchers for payment and also have access to unused
purchase orders.

Answer: A
In a typical cash disbursement system, approved check
vouchers and supporting documents are forwarded to the
cash disbursements department. This department having a
custodial function is responsible for signing checks, canceling
supporting documents, and mailing signed checks.
Which of the following procedures would give least
assurance of the existence of securities held by the
entity?

A. Confirmation from the custodian

B. Simultaneous count of liquid assets
C. Vouching all changes during the year to supporting
documentation.
D. Examination of paid checks issued in payment of
securities purchased
Answer: D
Examination of paid checks in payment for securities purchased does not
provide assurance that at the balance sheet date, the securities exist and are
still owned by the entity.
Which of the following best describes the scope of internal
auditing as it has developed to date?

A. Internal auditing involves appraising the economy and

efficiency with which resources are employed
B. Internal auditing has evolved to verifying the existence of assets
and reviewing the means of safeguarding assets.
C. Internal auditing has evolved to more of an operational
orientation from a strictly financial orientation.
D. Internal auditing involves evaluating compliance with policies,
plans, procedures, laws, and regulations.
Answer: C
Internal auditing includes the audit of:
1. Financial and operating information;
2. Compliance with policies, plans, procedures, laws, and contracts;
3. The means of safeguarding assets and verifying their existence;
4. The economy and efficiency with which resources are employed; and
5. Operations or program to ascertain whether results are consistent with established objectives and goals and
whether they are being carried out as prescribed.
Answers A, B, D are incomplete descriptions of the scope of internal auditing.
The statements below describe the interrelationship of audit risk
components. Which is false?

A. There is an inverse relationship between detection risk and the

combined level of inherent and control risk.
B. When inherent and control risks are high, the acceptable level of
detection risk needs to be low to reduce audit risk to an acceptably low
level.
C. When inherent and control risks are low, an auditor can accept a
higher detection risk and still reduce audit risk to an acceptably low
level.
D. The assessed level of inherent and control risks can be sufficiently
low to eliminate the need for the auditor to perform substantive
procedures.
Answer: D
The standard states that regardless of the assessed level of inherent
and control risks, the auditor should perform some substantive
procedures for material account balances and classes of transactions.
 The Nathalia Company is authorized to issue 600,000 shares at P10 par value common stock. Nathalia’s
accounting year ends on December 31. The following transactions occurred in 2013, the company’s first year of
operations.

-Issued 20,000 shares at P40 per share; received cash.

-Issued 2,500 shares to attorneys for services in securing the corporate charter and for preliminary legal costs
of organizing the corporation. The value of the services was P150,000.
-Issued 300 shares, valued objectively at P27,000, to the employees instead of paying them cash wages.
-Issued 125,000 shares of stock in exchange for a building valued at P1,950,000 and land valued at P700, 000.
(The building was originally acquired by the investor for P2,500,000 and has P1,000,000 of accumulated
depreciation; the land was originally acquired for P300,000.)

The amount of paid-in-capital in excess of par to be reported on Nathalia’s balance sheet at December 31,
2013 is

ANSWER: 1,949,000

a. (20,000X30) P400,000
a. (150,000-25,000) 125,000
a. (27,000-3,000) 24,000
a. (1,950,000+700,000-1,250,000) 1,400,000
Paid-in capital in excess of par P1,949,000
The balance in the Company’s accounts payable as of December 31, 2013
was P355,000 before any year-end adjustments relating to the following:

-Goods shipped FOB destination on December 21, 2013 from a vendor to

the Company were received on January 6, 2013. The invoice cost was
P75,000.
-Goods were in transit to the Company from a vendor on December 31,
2013. The invoice cost was P80,000. The goods were shipped FOB
shipping point on December 27, 2013 and were received on January 2,
2014.
-On December 27, 2013, the Company wrote and recorded checks to
creditors totaling P80,000 that were mailed on January 10, 2014.

In the Company’s December 31, 2013 statement of financial position, the

accounts payable should be

Unadjusted balance 355,000

A -
B 80,000
C 80,000
515,000
The Machinery account of Jonah Company contains the following entries during the year:

Date Item Debit Credit

2015
Jan. 1 Balance P1,750,000
June 30 Purchased four new machines 1,080,000
Installation cost of new machines 68,000
Sept. 30 Proceeds from sale of old machine, cost
P170,000; accumulated depreciation, P105,000 P 66,000
Oct. 31 Repairs of machinery 75,000
Dec. 1 Cash paid for trade-in of old machines—cost,
P90,000; accuulated depreciation, P36,000.
Cash price of new machine, P270,000 225,000
Dec. 31 Balance ________ 3,162,000
Total P3,228,000 P3,228,000

Assuming depreciation is recorded on a monthly basis at 10% a year, how much

was the depreciation charge for 2015?
Answer: P229, 650
Solution:
Remainder of beginning balance (P1,750,000 – P170,000 – P90,000 =
P1,490,000 x 10%) P149,000
June 30 acquisition (P1,148,000 x 10% x 6/12) 57,400
Sept. 30 sale (P170,000 x 10% x 9/12) 12,750
Dec. 1 trade in:
old machine (P90,000 x 10% x 11/12) 8,250
new machine (P270,000 x 10% x 1/12) 2,250
Depreciation expense for 2015 229,650
Lepant Co. was organized at the beginning of the current year. The following shareholders’ equity accounts are included in the
entity’s year-end trial balance.

The following current year transactions relate to Brandy Co.’s shareholders’ equity:

Immediately after Brandy Co. was organized, it received subscriptions to 80,000 preference shares. Subscriptions to ordinary shares
were also received on the same date.

During the year, subscriptions were received for an additional 15,000 preference shares at a price of P120 per share.

Cash payments were received from subscribers at frequent intervals for several months after subscription. The company’s policy is
to issue share certificates only upon full payment of the share subscription.

Also during the current year, Brandy Co. issued 24,000 ordinary shares in exchange for a tract of land with a fair value of P690,000.

The company’s statement of financial position at the end of the current year should report contributed capital of
Preference Ordinary
A.P8,540,000 P3,310,000
B.7,080,000 3,210,000
C.6,480,000 3,310,000
D.6,840,000 1,440,000
Answer: A
Solution:
Preference Ordinary
Issued P7,800,000 P 720,000
Subscribed800,000 720,000
Share premium 300,000 2,950,000
Subscriptions receivable (360,000) (1,080,000)
Contributed capital P8,540,00 P3,310,000
The following shareholders’ equity accounts are included in the statement of financial position ofChris Co. on December 31, 2014.

Preference share capital, 8%, P100 par (200,000 shares authorized,

60,000 shares issued and outstanding) P6,000,000
Ordinary share capital, P5 par (2,000,000 shares authorized,
600,000 shares issued and outstanding) 3,000,000
Share premium 3,750,000
Retained earnings 3,500,000
Total P16,250,000

During 2015, Chris took part in the following transactions concerning equity.

1. Paid the annual 2014 P8 per share dividend on preference shares and a P2 per share dividend on ordinary shares. These
dividends had been declared on December 31, 2014.
2. Purchased 81,000 shares of its own outstanding ordinary shares for P40 per share.
3. Reissued 21,000 treasury shares for land valued at P900,000.
4. Issued 15,000 preference shares at P105 per share.

5. Declared a 10% stock dividend on the outstanding ordinary shares when the shares are selling for P45 per share.
6. Issued the stock dividend.
7. Declared the annual 2015 P8 per share dividend on preference shares and the P2 per share dividend on ordinary shares.
These dividends are payable in 2016.
8. Reported net income of P9,900,000 for the current year.

What is the retained earnings balance (before appropriation for treasury shares) on
December 31, 2015?
Solution:
P3,500,000
(P2,430,000)
(P1,788,000)
+P9,900,000
Retained earnings 9,182,000
When the auditor includes an Emphasis of Matter paragraph in the
auditor’s report, the auditor shall do the following except:

A. Include it immediately after the Opinion paragraph in the auditor’s

report;
B. Use the heading “Emphasis of Matter,” or other appropriate heading;
C. Include in the paragraph a clear reference to the matter being
emphasized and to where relevant disclosures that fully describe the
matter can be found in the financial statements.
D. Indicate that the auditor’s opinion is modified in respect of the
matter emphasized.
Answer: D
According to PSA 706, the auditor shall do the following when including the Emphasis of Matter paragraph:

A. Include it immediately after the Opinion paragraph in the auditor’s report;

B. Use the heading “Emphasis of Matter,” or other appropriate heading;
C. Include in the paragraph a clear reference to the matter being emphasized
and to where relevant disclosures that fully describe the matter can be found in the financial statements.
D. Indicate that the auditor’s opinion is not modified in respect of the matter emphasized
The engagement team discussion that PSA 315 (Redrafted) and PSA 240 (Redrafted) requires
inclusion of specific consideration of the susceptibility of the financial statements to material
misstatement due to fraud or error that could result from the entity’s related party
relationships and transactions. The auditor shall inquire of management regarding the
following except:

A. The identity of the entity’s related parties, including changes from the prior period
B. The amount of the transaction between the related parties.
C. The nature of the relationships between the entity and these related parties
D. Whether the entity entered into any transactions with these related parties during the
period and, if so, the type and purpose of the transactions.

Answer: B
According to PSA 550 (revised and redrafted) Related Parties, in consideration of the susceptibility of
the financial statements to material misstatement due to fraud or error that could result from the
entity’s related party relationships and transactions, the auditor shall inquire of management
regarding:
The identity of the entity’s related parties, including changes from the prior period;
The nature of the relationships between the entity and these related parties; and
Whether the entity entered into any transactions with these related parties during the period and, if
so, the type and purpose of the transactions.
Under the PSA 315, monitoring of controls is an internal control
component that involves a process of assessing the quality of internal
control performance over time. It involves a process of assessing the
design and operation of controls on a timely basis and taking necessary
corrective actions. Monitoring of controls is accomplished through
ongoing monitoring activities. An entity’s monitoring activities include:

A.Reviewing the purchasing function

B. Periodic audits by the audit committee
C. Periodic reporting by the entity’s internal auditors about the
functioning of internal control.
D. The audit of annual financial statements

Answer: A
According to the standard, ongoing monitoring activities are built into the
normal recurring activities of an entity and include regular management
supervisory activities, such as reviewing the purchasing function.
Under the PSA 610 Using the work of internal auditors, to determine the
adequacy of specific work performed by the internal auditors for the
external auditor’s purposes, the external auditor shall evaluate the
following except:

A. The work was performed by internal auditors having adequate

technical training and proficiency
B. Adequate audit evidence has been obtained to enable the internal
auditors to draw reasonable conclusions
C. Conclusions reached are appropriate in the circumstances and any
reports prepared by the internal auditors are consistent with the results of
the work performed; and
D. Any exceptions or unusual matters by the internal auditors are
properly disclosed.
Answer: D
According to PSA 610, the external auditor shall evaluate the following:
The work was performed by internal auditors having adequate technical training and proficiency;
The work was properly supervised, reviewed and documented;
Adequate audit evidence has been obtained to enable the internal auditors to draw reasonable conclusions;
Conclusions reached are appropriate in the circumstances and any reports prepared by the internal auditors are
consistent with the results of the work performed; and
Any exceptions or unusual matters disclosed by the internal auditors are properly resolved.
On January 1, 2016, Nate signed an agreement to operate as franchisee of
Copylandia Service, Inc. for an initial franchise of P680, 000. Of this amount, P260,
000 was paid when the agreement was signed and the balance was payable in four
annual payments of P120, 000 each, beginning January 1, 2017. The agreement
provides that the down payment is not refundable and no future services are
required of the franchisor. The implicit rate for loan of this type is 14% . The
agreement also provides the 5% of the revenue from the franchise must be paid to
the franchisor annually. Nate’s revenue from the franchise for 2010 was P8, 000,
000. Nate estimates that the useful life of the franchise is to be ten years.

What is the total expense related to the franchise in 2016?

Answer: 509, 914

Solution:
Down payment 260, 000
Add: PV of installment payments (120, 000 x 2.9137) 349, 644
Cost of franchise 609, 644
Divide by useful life 10
Amortization of franchise 60, 964
Periodic franchise fee (8, 000, 000 x 5%) 400, 000
Imputed interest expense (349, 644 x 14%) 48, 950
Total expense related to franchise in 2016 509, 914
The physical inventory of ABC Inc. as of December 26, 2014 totaled P985,000. You agreed on the
December 26, 2014 count as the company has a good internal control system. In trying to establish
the December 31 inventory, you noted the following transactions from the December 27 to
December 31, 2014.

Sales (30% mark-up on cost) P585,000

Credit memos issued:

For goods returned on:
a. December 15 10,800
b. December 20 18,000
c. December 29 15,600
For goods delivered to customers not in accordance with specifications
3,600

Credit memos received:

For goods received on:
a. December 10 5,400
b. December 26 4,200
c. December 28 6,000

Purchases:
Placed in stock 90,000
In transit, FOB shipping point 124,500
In transit, FOB destination 39,000

What is the inventory balance on December 31, 2014?

Answer: P755,500
Solution:
Inventory per count, December 26, 2014 P985, 000
Add (deduct) transactions, December 27 – 31, 2014
Cost of goods sold (P585,000 / 130%) (450,000)
Goods returned by customers on December 29 (P15,600 / 130%) 12,000
Goods returned to suppliers on December 28 (6,000)
Purchases placed in stock 90,000
Purchases in transit, FOB shipping point 124,500
Inventory balance, December 31, 2014 P755,500
ABC Company leased office premises to XYZ Company for
a 5-year term starting January 2, 2014 Under the terms of
the lease, rent for the first year is P200,000 and rent for
years 2 through 5 is P300,000 annually. As an inducement
to enter the lease, ABC Company waives the first six
months of rental payments. XYZ Company likewise paid a
P70,000 security deposit of which 80% is refundable at the
end of the lease term. Furthermore, contingent rent equal
to 2% of sales in excess of P12,000,000 shall be paid by
XYZ Company. ABC Company incurred initial direct cost of
P40,000 while XYZ Company paid P30,000 in costs in
relation to the lease. In 2015, XYZ Company reported sales
of P13,000,000.

Rental expense to be included in XYZ Company’s 2015

income statement is
Answer: P288,800
Total rental payments for five years (P200,000/2) + (P300,000*4) P1,300,000
Divided by total years 5 years
Annual rental expense (fixed) 260,000
Contingent rent [(13M – 12M) * 2%] 20,000
Direct cost incurred (30,000 / 5) 6,000
Non-refundable portion of security deposit (70,000 * 20%) / 5 2,800
Total rental expense P288,800
ABC Company leased office premises to XYZ Company for
a 5-year term starting January 2, 2014 Under the terms of
the lease, rent for the first year is P200,000 and rent for
years 2 through 5 is P300,000 annually. As an inducement
to enter the lease, ABC Company waives the first six
months of rental payments. XYZ Company likewise paid a
P70,000 security deposit of which 80% is refundable at the
end of the lease term. Furthermore, contingent rent equal
to 2% of sales in excess of P12,000,000 shall be paid by
XYZ Company. ABC Company incurred initial direct cost of
P40,000 while XYZ Company paid P30,000 in costs in
relation to the lease. In 2015, XYZ Company reported sales
of P13,000,000.

Rental expense to be included in XYZ Company’s 2015

income statement is
Answer: P288,800
Total rental payments for five years (P200,000/2) + (P300,000*4) P1,300,000
Divided by total years 5 years
Annual rental expense (fixed) 260,000
Contingent rent [(13M – 12M) * 2%] 20,000
Direct cost incurred (30,000 / 5) 6,000
Non-refundable portion of security deposit (70,000 * 20%) / 5 2,800
Total rental expense P288,800
STAR LABORATORIES holds a valuable patent (No. 112170) on a device that prevents certain types
of air pollution. Star does not manufacture or sell the products and processes it develops; it
conducts research and develops products which it patents, and then assigns the patents to
manufacturers on a royalty basis. The history of Patent No. 112170 is as follows:

Date Activity Cost _

2005-2006 Research conducted to develop device P1,259,100
Jan. 2007 Design and construction of a prototype 262,800
Mar. 2007 Testing of model 126,000
Jan. 2008 Legal and other fees to process patent application;
patent granted June 2008 86,150
Nov. 2009 Engineering activity necessary to advance the design of the
Device to the manufacturing stage 244,500
April 2011 Research aimed at modifying the design of the patented device 129,000
May 2015 Legal fees paid in a successful patent infringement suit
against a competitor 102,000
----------------------------------------------------------------------------------------------------------
Star assumed a useful life of 17 years when it received the initial device patent. On January 1,
2013, it revised its useful life estimate downward to 5 remaining years. Amortization is computed
for a full year if the cost is incurred prior to July 1 and no amortization for the year if the cost is
incurred after June 30. Star’s reporting date is December 31, 2015.

Compute the carrying value of Patent No. 112170 on December 31, 2015
Answer: P52,560
Cost to obtain patent (January 2008) P186,150
2008 amortization (P186,150/17) (10,950)
Carrying value, Dec. 31, 2008 P175,200

Carrying value, Jan. 1, 2009 P175,200

Amortization, 2009-2012 (P10,950 x 4 years) (43,800)
Carrying value, Dec. 31, 2012 P131,400

Carrying value, Jan. 1, 2013 P131,400

Amortization, 2013-2015 (P131,400 x 3/5) (78,840)
Carrying value, Dec. 31, 2015 P 52,560
On January 1, 2014, Melanie Mfg. Co. began construction of a building to be used as its office
headquarters. The building was completed on June 30, 2015.

Expenditures on the project were as follows:

January 3, 2014 P2,500,000

March 31, 2014 3,000,000
June 30, 2014 4,000,000
October 31, 2014 3,000,000
January 31, 2015 1,500,000
March 31, 2015 2,500,000
May 31, 2015 3,000,000

On January 3, 2014, the company obtained a P5 million construction loan with a 10% interest rate.
The loan was outstanding all of 2014 and 2015. The company’s other interest-bearing debts
included a long-term note of P25 million with an 8% interest rate, and a mortgage of P15 million
on another building with an interest rate of 6%. Both debts were outstanding during all of 2014
and 2015. The company’s fiscal year-end is December 31.

What is the amount of capitalizable interest in 2014?

Answer: P663, 125

Actual borrowing cost:

Specific borrowing (P5 million x 10%) P500,000
General borrowings:
P25 million x 8% P2,000,000
P15 million x 6% 900,000 2,900,000
Total P3,400,000
Capitalization rate (P2,900,000/P40 million) 7.25%
Average expenditures – 2014 P7,250,000
Capitalizable interest – 2014:
Specific borrowing (P5 million x 10%) P500,000
General borrowings (P7,250,000 – P5,000,000 = P2,250,000 x 7.25%) 163,125
Total P663,125