CPA REVIEW SCHOOL OF THE PHILIPPINES AP-7 4AL

ttlanila
AUDITING PROBTEMS CPA Review

AUDIT OF SHAREHOLDERS' EQUITY

PROBLEM NO" T

BEBE CO. was formed on July 1, 2010. It was authorized to issue 1,800,000 shares of P10 par
value ordinary shares and 600,000 shares of 8 percent P25 par value, cumulative and
nonparticipating preference shares. BEBE CO, has a July l-June 30 fiscal year.

The following information relates to the shareholderc'equity accounts of BEBE CO.:

Ordinary Sharcs

Prior to the 2012-2013 fiscal year, BEBE CO. had 660,000 ordinary shares issued as follows:

1. 510,000 shares were issued fclr cash on July 1,2AlA, at P31 per share.
2. On July 24, 20LA,30,000 shares were exchanged for a plot of land which cost the seller
P420,000 in 2004 and had an estimated market value of P1,320,000 on July 24,2A10'

3. 120,000 shares were issued on March L,20LL, far ?42 per share.

During the 2012-2013 fiscat year, the following transactions regarding ordinary shares took
place:

November 30,7IOLZ BEBE CO. purchaseci 12,000 of its own shares on the open market at
P39 per share.

December L5,2AL2 BEBE CO. declared a 5o/o share dividend for shareholders of record on
January 15, 201"3, to be lssued on January 31, 2013. BEBE CO. was
havinE a liquidity problem and could not afford a cash dividend at the
time. BEBE CO.'s ordinary shares were selling at P52 per share on
December 15, 2At2.

June 20, 2013 BEBE CO. sold 3,000 of its own ordinary shares that it had purchased
on November 30, 2:012, for P126,000.

':.
Prefercnce Shares
'r.
"ll"' "' BEBE CO. issued 240,000 preference shares atP44 per share on July L, 201L.

Cash Divldends

BEBE CO. has followed a schedule of declaring cash dividends in December and June, with
payment being made to shareholders of record in the following month. The cash dividends
which have been Ceclared since inception of the company through June 30, 20L3, are shown
below:
Declaration Date Share Cagital-Ordinarv* thare Caoital-Preference
LzlL5lll P0.30 per share P1.00 per share
O6/tSltZ P0,30 per shai'e P1.00 per share

No cash diwdends were declared during June 2013 due to the company's liquidity problems.
CPAR - MANIIS _ _ AP7aO1-AUDIT OF SHAREI@ER

Retaimed EarnEnEs

As of June 30, 2AL2, BEBE CO's retained earnings acccunt had a balance of P4,140,000. For
the fiscal year ending June 30, 2013, BEBE CO, reported'net income of P240,000'

Required:
Compute the adjusted baiances of the following as of ,lune 30, 2013:

Share capital-preference
Share capital-ordinary
Share prernium-preference
Share premir-;m--ordinary
Share prernium-treasu ry
l.talgq3grygf _Q.t'",._gpp'ggf!91 !: ESIY lEIg{_
Treasury shares
Total sharehoiders' equity

oesrlsss $s0$mses

PROBLEM NO. 2

The sharehoklers'equity section of BAHfu-[N CORFORATION's staternent of financiiil position as

of December 31, 20L2, is as follcws: I

Share capital{rdinary (P10 par, 750,00C shares

authorized, 412,500 issued anci or-rtstanding) P4,17_5,000
Share premiunr *geilgg
Total paid-in capital P4,950,000
Unappropriated retained earnings P2,002,500 I
I

_25!,800
I

Appropriated retained earnings

2/sl,ru
I

Total retained earnings

Total shareholders' equicy P7-192,590

Bahrain Corporation had the follovuing sl'laretrolclers'equity transactions during

2013:

lan. 15 Completed the buiiding renovation for u,,liich P750,0Cr0 of retair,etJ earningl had been
restricted. Paid the contractor P727,50A, all of whicir is capitali;ed'

Mar. 3 trssuect ..150,000 additional ordinary shares for P18 per shai"e.

May 18 - -"t 31, 2Ai3, to shalreholders of

-'
r- -' on July
Declared a dividend of P1,50 per share to be paid --'
recoi'rJ on June 30, 2013. I

June 19 Approved additional building renovation to be fundecl internally" The estimated cost of
the project is P500,000, anci reteined earnings are tcr be r..:sti-icted for that amount.

July 31 Paid the dividend.

Nov,1"2 Declared a properq di'riCend to be paid on Jar;li:ry' 5, 2Ji4, lhe dividcnd is to consist
'l"air value of P472,500 on
o1egiripment that hat a carrying arnr-runt of P350,tiC0 anrJ a
hlovernber 12,

Dec. 31 Net ilrc;ome for 2013 (befr:lre recognii-i,:n cf lmpairmerrt loss oo thi'? equipment declared
as propefi dividend) is P1.,32.7,500. Tlre equiprnent's feii" r,'alue iess cosi to distribute
on December 31 is P330,000.
oPAR - MAN,|LA _ _ 4p7401- Auprr OF SHAREHOLDERy EQUITY

--
1. Share capital--ordinary on December 31, 2013, is
A. P5,625,CCI.3 B. P4,125,000 c. P4,950,000 D. P7,650,000

2. Share premiurn on December 31, 2013, is

A. P2,625,000 B. P825,000 c. P2,025,000 D. P1,200,000

3. Unappropriated retained earnings on December 31, 20L3, is

A. P2,L63,754 B. P2,246,254 c.
P2,L33,750 D. P2,276,250

4. The total shareholders'equity on December 31, 2013, is

A. PL0,376,250 B. P10,525,250 c.
P9,926,250 D. P7,650,000

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PROBLEM NO.3

You were engaqed by CITY CORPOMTIOITI, a publicly held company whose shares are traded
on the Philippine Stock Exchange, to conduct an audit of its 2013 financial statements. You
were told by the company's controller that there were numerous equity transactions that took
place in 2013. The shareholders' equity accounts at December 31, 2012, had the following
balances:

Share capital--Preference, P100 par value, 5Yo curnulative;

30,000 shares authorized; 18,000 shares issued
and outstanding P1,800,000
Share capital--Ordinary, Pl par value, 1,800,000 shares authorized;
1,200,000 shares issued and outstanding 1,200,000
Share premium 2,400,000
Retained earnings 980.000
Total shareholders' equity P6.380.000

You summarized the following transactions during 2013 and other information relating to the
shareholders'equity in your working papers as follows:

. Januaty 6, 2013 -
Issued 45,000 ordinary slrares in exchange for land. On the date
issued, the shares had a rnarket price of P16.50 per share. The land had a carrying value of
P420,000, and an assessed value fcr properlrT taxes of P490,000.

. January 3X., 2OL3 -' Sold 2,400, P1,000, 12olo bonds due January 3L, 2023, at 98 with one
detachable share warrant attached to each bond. Interest is payable annually on January
31. The fair value of the bonds without the share warrants ]s 95. The detachable warrants
have a fair value of P50 each and expire on January 31, 2014. Each warrant entiUes the
holder to purchase 10 ordinary shares at P10 per share,

. Februanr 22,2013 - Purchased 15,000 of its ornn ordinary shares to be held as treasury
shares for P24 per share.

. Februar\ 28, 2013 - Subscriptions for 42,0AA ordinary shares were received at P26 per
share, payable 50o/o down and the balance by March 15.

. March 15, 2013 - The balance due on 36,000 ordinary shares was received and those
shares were issued. The subscriber who defaulted on the 6,000 remaining shares forfeited
the dolvn payment in accordance wlth the subscription agreement.

. August 30, 2013 - Reissued 6,000 treasury shares for P20 per share.

' September 1.4, ?013 - There were 1,890 warrants detached from the bonds and
exercised.
GPAR - MANTLA ,- SHAREI-|oLDERS'EQUITY

--------AgZ4o1-Auttlr.oF .

-
o November 3O, 2013 Declared a cash diviciend r:f Pll.50 per share to all ordinary
-
shareholders of record December 15, 2013. TIre dhrldend was paid on Decernber 30, 2013.

. December 15, 2013 - Declared the required annual cash dividends on preference shares
I

for 2013. The dividend was paid on January 15, 2014,

r Janu?rT 8/ 2014 -- Before closing the accountirrg records for 2013, CffY became aware
that no depreciation had been recorded for 2012 for a machine purchased on 1,tuly 1,2012.
The machine was properly capitalized at P960,000 and had an estlmated useful life of eight
years when purchased. The appropriate correciing entn, was i'ecorded cn the same date.
I

. Adjusted net income for 2013 was P840,000.

Eased on the foregoing and the result of yctur audid answer tke following:' (Ignore income tax
implications.)

1. Shai'e capital-orrJinary at December 31, 2013, is

A" PX.,290,900 B. P1,305,900 C. P1.,281,00G tr. ptr,299,900
l

2. How much is the total share premium as of Dc:cember 31, 2013?

P4,239,60A B. P4,317,600 P4,363,200
I

A. C. D. P{,065,100

3. The unappropriated retained earnings ort Decernber 3J., 2013, is I

A. P982,550 B. P622,55A C, P766,550 D. P790,550

4. How much is the total sharehoiders'equitry cn Decemtrer 31, 2013?

A. P8,184,050 B. P7,958,050 C. P8,168,750 D, P8,190,050

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PROBLEM T{G. 4

A CPA was engeged by BIRDIE Company in 2013 to examine its books and records and to make
whatever corrections are necessary. An exarr'inaticn of tlre accounts discloses the following:

a) Dividends had been declared on Decenrbrr 15 in 2fiii and 2012 but hrad not been
entered in the books until paid.

b) Imilrorrenients in buildings and equipnreni of P32,400 har.i treen debited to expense at

the end of April 2010. Imprcvemenl"s are E:stin,aterd to have L2-year life. The company
uses the straigtrt-line method in :'ec;ordin-q tlep,reciatiorr a:td cumputes depreciation to
the nearest month.

c) The physical inventory of merciianciise hacj been unclerstated by P9,500 at the end of
2011 and by P14,250 at the r:nd of 2012.

d) The merchandise of 2C12 anci 201.3 did nct include merchandise

inr.,entories at the entJ
tliai was then in transit dr;drvhich tlre con-rpa,'rv had tltlt., These shiptnents of P6,300
Lo
and P8,700 were recorcied as purchases in Januar',r ,:i ?Ci3 arrd 201.4, respectively.

e) The cornpany had failed to record sales cornriissioirs payabie of F'10,800 and P3,300 at
the end of 2012 and 2013, respe#-ively,

0 Tlre company had failecj to reccrgnize supptlr:s on I'ranc of F2,550 and P5,160 at the end
of 2012 and 20i3, resoectively.
CPAR - MANILA AP7'}01- AUDIT OF SHAREHOTDERY EQUITY
-
The retained earnings account appeared as shown below on the date the CPA began the
examination.

Retained Earnings
D?te Item Debit Credit Balance
2011
Jan. 1 Balance P195,000
Dec. 31 Net income for year P84,000 279,044
20L2
Jan. 10 Dividends paid P46,500 232,500
Mar. 6 Stock sold-excess over par 63,000 295,500
Dec, 31 Net loss for year 53,400 242,LA}
20r.3
Jan" 10 Dividends paid 46,500 1.95,600
Dec. 31 Net loss for year 57,900 L37,7OA

1. What is the corrected 2011 net income?

A.P124,244 B. P90,900 c. P121,500 D. P7L,70A

2. What is the corrected 2012 net loss?

A. P53,400 B. P66,000 c, P54,300 D. P59,700

3. What is the corrected 2013 net loss?

A. P64,744 B. P62,340 c. P56,040 D. P7LA40

4. What is the corrected retained earnings on December 31, 2AL2?

A. ?226,200 B. P163,800 c. P100,800 D. P183,060

5. What is the corrected retained earnings on December 31, 20L3?

A. P63,000 B. P99,060 c. P92,760 D, P36,060

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PROBLEM NO. 5

At the beginning of year 1, Entity A grants share options to each of its 100 employees working
in the sales department. 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 100 share options. If the volume of sales increases by an average of between 11
percent and 15 percent each year, each employee will receive 200 share options. If the volume
of sales increases by an average of 16 percent or more, each employee will receive 300 share
options.

On grant date, Entity A estimates that the share options have a fair value of P20 per opUon.
Entity A also estimates that the volume of saies 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 the 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 seruice for the three-year period. Prcduct sales have increased by L2 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 percent over the two years to date, The entity now
CPAR. MANILA APTrtOl - AUDIr OF sH4EEHOlgEr$'_Erru!l_!.

expects tl'lat sales will average 16 percent cr more over the three-year period, and hence
expects each sales employee to receive 300 share options at the end of year 3.

left, Hence, 14 employees have left during

By the end of year 3, a further two employees have
the three-year period, and 86 employees remain. The entity's sales have increased by an
average of 16 percent over the three years.

Based on the preceding information, answer the follor,vingJ:

1. What is the compensation expense for year 1?

A. P106,667 B. P53,333 c. P160,000 D. P172,000

2, What is the compensation expense for year 2?

A, P286,667 B. P180,000 c. P233,333 D. P168,000

3. What is the compensation expense for year 3?

A. PtL4,667 B. P176,000 c. P282,667 D. P188,000

4. What is the cumulative compensation expense for years L,2, and 3?

A. P320,000 B. P516,000 c. P344,000 D. PL72,000

5. At the end of year 2, the entity should report share options outstanding of
A, P328,000 B. P226,667 C" P286,667 D. P340,000

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PROBLEM NO. 5

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 three years.

During year 1, 35 employees have [eft, 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 fufther 25
lvill leave during year3. 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 values of the SARs at the date of exerr:ise (which equal the cash paid out) at the end of
years 3, 4 and 5 are also shown below.
Year Fair Value Intrinsip Value_
1 PL4,4O
2 15.50
3 18.20 P15.00
4 2L.44 20.00
5 25,00
R.EQUIRED:
Compute the amounts of compensation expense and liability that the entity should report in
years 1 to 5.
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PROBLEM NO.7

An entity grants to an employee the right to choose either 1,000 phantom shares (i,e., a right
to a cash payment equal to the value of 1,000 shares) or 1,200 shares with a par value of P10
per share. The grant is conditional upon the completion of three years' service. If the
employee chooses the share alternative, the shares must be held for three years after vesting
date.
 CPAR - MANIIA APTAU . AUDIT OF SHA

At grant date, the entity's share price is P50 per share, At the end of years l, 2 and 3, the
share price is P52, P55 and P60 respectively. The entity does not expect to pay dividends in
the next three years. After taking into account the effects of the post-vesting transfer
restrictions, the entity estimates that the grant date fair value of the share alternative is P,lB per
share.

At the end of year 3, tlic employee chooses:

Scenario 1: The cash alternative

Scenario 2: The equity alternative

Based on the preceding information, answer the following:

1. What is the total fair value of the equity component as a result of the share-based
payment transaction with settlement a lternatives?
A. P7,60A B" P10,000 C. P2,40A D. P0

2. What is the compensation expense in year 1?

A. PL7,333 B. P19,866 C. P19,333 D. P23,334

3. What is the compensation expense in year 2?

A. P19,866 B. P17,333 C. P2L,B67 D. P19,333

4. What is the compensation expense in year 3?

A. ?23,334 B, P25,867 C" P19,333 D. P19,866

5. If the employee has chosen the cash alternative, the amount to be paid at the end of year
3 should be
A, P55,000 B. P67,600 C, P52,000 D. P60,000

6. If the employee has chosen the share alternative, the amount of share premium to be
recognizeci is
A, P7,600 B. P55,600 C. P60,000 D, P67,6AA
sooomfficsegoq
PROBLEM NO.8

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

A. Capital stock 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
I transfer agent.

2. In an audit of a n:edlum-sized manufucturing concern, which one of the following areas

can be expected to require the least amount of audit time?
A. Owner's equity
B. Assets
C, Revenue
D. Liabilities
3. 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 numbers.
CPAR - MANILA AP74O1 - AUDIT OF SHAREEOTPEBSIqUTY

4. When a client company does not maintain its own stock records, the auditor should obtain
written confirmation from the transfer aEent and registrar concerning
A. Restrictions on the payment of dividends.
B, The number of shares issued and outstanding.
C. Guarantees of preferred stock liquidation value,
D. The number of shares subject to agreennent to :epurchase.

5. The auditor is concerned with establishing that dividends are paid to client corporation
shareholders owning stock as of the
A. Issue date C. Record date
B. Declaration date D. Payment date

6. An audit program for the retairied earnilrEs account shout<J include a step that requires
verification of the
A, Fair r.ralue used to charge retained earnings to account for a hvo-fcrr-one stock split.
ts. Approval of the atijustrnent to the beEinning balance as a result of a write-down of an
account receivable.
C. Authorization for both cash and stock dividencis.
D. Gain or loss arising from dispositiorr of treasury shares.

7. During an audit of an entity's sharehoiders' equity' accoui'its, the auditor determines

whether there are restrictions on retained earnings resulting from loans, agreements, or
Iaw. This audit procedure most iikely is intended to verifo management's assertion of
A. Existence
B. Completeness
C. Valuation
,

D. Presentation and disciosure

8. If the auditee has a material amount of rreasury stock on hanrj at year-end, the auditor
shnuld
A. Count the rcrtificates at the same time other securities are counted"
B. Count the certificates E:nl.y if the company had treasury s'icck transactiori,rs during the
year" I

C. Not count the ceftificates if treasury st:ock is a deduction from shareholde{s'equity.

D- Count the certificates only if the company classifles treasury stock with ottfer assets.
I

9, In perfornring tests concerning the grarrting of stock options, an auditor shoutU

A, Ccnfirrn the transaction with the Seciriities and Exchange Commission. I

B, Verify the existence of option hr:iclers in the eniity's peyoll records or sto(f ledgers.
C. Deterrnine that sufficient treasury st'ock is available to cover anv neirv stock issued.
D. Trace the authorization for the transaction to a vote o{'the board of dii"ectors.

10. The audltcr u,rould nct expect the clicnt trr debit fetainerj earnings for which of the
following transactions?
A, A 4-for-L stock split.
B, "Loss" arrsinE frorn dispc;sition of treasury shares.
C. A 1-for-10 stock dividend.
D. Correction of error affecting prior year's earnings.
^..- E'NIr -*