CPA REVIEW SCHOOL OF THE PHILIPPINES

First Preboard Examination on Auditing Problems

Suggested answers/solutions

PROBLEM NO. 1 - Jewel in the Palace Corporation

Jewel in the Palace Corporation
Corrected balance sheet
December 31, 2006

Assets
Current assets
Cash 180,200
Accounts receivable, net (P450,000 - P19,200) 430,800
Inventory (P816,000 - P180,000) 636,000
Prepaid insurance 35,200 1,282,200 1 C

Noncurrent assets
Property, plant and equipment, net
[(P2,227,200-P340,000) -(P720,000-P340,000)] 1,507,200
Advances to officers 23,600 1,530,800 2 A

Total assets 2,813,000 3 D

Liabilities
Current liabilities
Accounts payable (P301,000+P65,000) 366,000
Salaries payable 38,000
Income tax payable 73,000
Loan payable to bank, current portion (P25,000x4) 100,000 577,000 4 B

Noncurrent liabilities
Loan payable (P304,800-P100,000) 204,800
Deferred tax liability 178,200 383,000 5 A
Total liabilities 960,000 6 D

Owners' Equity
Contributed capital
6% Preferred stock, P20 par, 25,000 shares 500,000
Common stock, P1 par value, 36,000 shares 36,000
Paid-in capital in excess of par
(P1,134,400-P500,000-P36,000) 598,400 1,134,400 7 B
Retained earnings
(P1,832,400-P598,400-P19,200-P180,000-P65,000-P73,000-P178,200) 718,600
Total owners' equity 1,853,000 8 A

Total liabilities and owners' equity 2,813,000

9 D
10 A
PROBLEM NO. 2 - Jang Geum Corporation
Question no. 11 - C
Sales proceeds 152,000
Less CV of shares sold (P288,000 x 8/16) 144,000
Gain on sale of 8,000 Explorer, Inc. shares 8,000

Question no. 12 - C
Sales proceeds (3,200 shares x P15) 48,000
Partial realization of unrealized gain (P320,000 x 3.2/80) 12,800
Total 60,800
Less CV of shares sold (P1,280,000 x 3.2/80) 51,200
Gain on sale of 3,200 Midas, Inc. shares 9,600

Alternative computation:
Sales proceeds (3,200 shares x P15) 48,000
Less cost of shares sold (P960,000 x 3.2/80) 38,400
Gain on sale of 3,200 Midas, Inc. shares 9,600

Question no. 13 - B
Vanguard bonds (P200,000 x 10%) 20,000
Discoverer bonds (P1,926,000 x 14%*) 269,640
Total interest income for 2006 289,640

*Computation of effective interest rate:

Carrying value, 12/31/05 1,926,000
Less carrying value, 1/2/05 (Cost) 1,900,000
Discount amortization for 2005 26,000
Add nominal interest (P2,000,000 x 12%) 240,000
Effective interest 266,000
Divide by carrying value, 1/2/05 1,900,000
Effective interest rate 14.00%

Question no. 14 - C
Carrying value, 12/31/05 1,926,000
Add discount amortization in 2006:
Effective interest (P1,926,000 x 14%) 269,640
Nominal interest (P2,000,000 x 12%) 240,000 29,640
Carrying value, 12/31/06 1,955,640
Fair value of Discoverer bonds on 12/31/06 (P2M x 1.01) 2,020,000
Unrealized gain on transfer of securities to be reported under SH 64,360

Question no. 15 - A
Trading securities
Sputnik, Inc. (9,600 x P22) 211,200
Explorer, Inc. [(16,000 - 8,000) x P15] 120,000
10% , P200,000 face value , Vanguard bonds 151,200
Total market value 482,400

Available-for-sale securities
Score Products (32,000 x P42) 1,344,000
Tiros, Inc. (240,000 x P28) 6,720,000
Midas, Inc. [(80,000 - 3,200) x P18] 1,382,400
Discoverer bonds (P2,000,000 x 1.01) 2,020,000
Total market value 11,466,400
PROBLEM NO. 3 - Jung Ho Corporation
Question No. 16 - A
Land, 1/1/06 600,000
Plant facility-portion of FV allocated to land
[(40,000 x 37) x 460/(460+1,380)] 370,000
Land, 12/31/06 970,000
Note: The land acquired with undetermine use will be classified as Investment Property.

Question No. 17 - D
Buildings, 1/1/06 2,200,000
Plant facility-portion of FV allocated to building
[(40,000 x 37) x 1,380/(460+1,380)] 1,110,000
Buildings, 12/31/06 3,310,000

Question No. 18 - B
Machinery and equipment, 1/1/06 1,920,000
Acquired, 5/1/06 [(P896,000/1.12)+P26,000+P52,000] 878,000
Scrapped, 6/30/06 (160,000)
Sold, 7/1/06 (88,000)
Machinery and equipment, 12/31/06 2,550,000

Question No. 19 - B
CV of machine, 6/30/06 (P160,000x.8x.8x.8x.8x.8x.8x.8x.8x.9) 24,159

Question No. 20 - A
Sales proceeds 40,000
Less carrying value, 7/1/06:
Cost 88,000
Less accumulated depreciation [(P88,000-P4,000) x 3.5/7] 42,000 46,000
Loss on sale of machine on 7/1/06 (6,000)

PROBLEM NO. 5 - Lady Han Cookie Corporation

Question no. 26 - C
Legal expenses to obtain patent 480,000
Expense of drawing required by the patent office 68,000
Fees paid to the government patent office 100,000
Cost of patent 648,000

Question no. 27 - D
Metal used in the construction of the machine 320,000
Blueprints used to design the machine 128,000
Wages paid to the employees (P1,200,000 x 60%) 720,000
Cost of machine 1,168,000

Question no. 28 - A
Research and development laboratory expenses 1,000,000
Wages paid to the employees (P1,200,000 x 40%) 480,000
R & D expense 1,480,000

Question no. 29 - C
Cost of patent (see no. 26) 648,000
Less amortization up to 12/31/06 (P648,000 x 2/20) 64,800
Carrying amount of patent, 12/31/06 583,200

Notes: Cost of defending the patent should be expensed

Since the useful life is not given, the patent was amortized using
the legal life of 20 years.

Question no. 30 - D
PROBLEM NO. 4 - Jungjong Corporation
Question no. 21 - B
Cost of land—2001 50,000
2002 cost to build road 5,000,000
2002 mine improvements 750,000
Total 2001–2002 cost 5,800,000
Less residual value 600,000
Cost subject to depletion 5,200,000
Divide by total estimated reserves 4,000,000
2004 depletion per ton 1.30

Depletion for 2004 (5,000 x P1.30) 6,500

Question no. 22 - C
Original cost to be depleted 5,200,000
Less 2004 depletion 6,500
Remaining cost 5,193,500
2005 mine improvements 275,000
New cost to deplete 5,468,500
Divide by remaining estimated reserves
(4,000,000 - 5,000 +3,000,000) 6,995,000
2005 depletion per ton 0.78

Depletion for 2005 (1,000,000 x P0.78) 780,000

Question no. 23 - D
Building cost (2003) 1,500,000
Less salvage value 250,000
Original cost to be depreciated 1,250,000
Less 2004 depreciation (5,000 x P0.31) 1,550
Remaining cost 1,248,450
2005 new building 225,000
New cost to depreciate 1,473,450
Divide by remaining estimated reserves (see no. 22) 6,995,000
2005 depreciation per ton 0.21

Depreciation for 2005 (1,000,000 x P0.21) 210,000

Question no. 24 - C
Remaining cost—beginning of 2005 5,468,500
Less 2005 depletion 780,000
Remaining cost—beginning of 2006 4,688,500
2006 mine improvements 1,100,000
New cost to deplete 5,788,500
Divide by remaining estimated reserves
(6,995,000 - 1,000,000) 5,995,000
2006 depletion per ton 0.97

Depletion for 2006 (2,500,000 x P0.97) 2,425,000

Question no. 25 - A
Depreciation for 2006 (2,500,000 x P0.21) 525,000
PROBLEM NO. 6 - Lady Choi Corporation

Question no. 31 - A
% of Est. Estimated
Month Sales Returns Returns
January 5,400,000 8% 432,000
February 4,950,000 8% 396,000
March 6,150,000 8% 492,000
April 4,275,000 8% 342,000
May 3,000,000 10% 300,000
June 2,700,000 10% 270,000
2,232,000
Question no. 32 - C
Warranty expense (P2,232,000 x 75%*) 1,674,000

Computation of loss percentage on returns (in percentage of sales price):

Cost of unit replacement 80%
Freight charges on return and replacement 10%
Salvage value of components returned -15%
Net loss on components returned 75%

Question no. 33 - B
% of Est. Estimated
Returns Returns
Estimated Subsequent to Subsequent
Month Returns 6/30/05 to 6/30/05
January 432,000 10% 43,200
February 396,000 20% 79,200
March 492,000 30% 147,600
April 342,000 50% 171,000
May 300,000 80% 240,000
June 270,000 100% 270,000
2,232,000 951,000

Estimated Liability for Product Warranty, 6/30/06 (P951,000 x 75%*) 713,250

Question no. 34 - A

Warranty Expense 592,875

Estimated Liability for Product Warranty 592,875

Estimated Liability for Product Warranty, 6/30/06 - as adjusted 713,250

Estimated Liability for Product Warranty, 6/30/06 - per books 120,375
Adjustment 592,875

Question no. 35 - D
PROBLEM NO. 7 - Lady Choi Corporation
Nominal interest (P2,000,000 x 11%) 220,000
Effective interest (P2,000,000 x 9%) 180,000
Difference 40,000
Multiply by PV of an ordinary annuity of P1 at 9% for 5 periods 3.8897
Premium 155,588
Face value 2,000,000
Issue price 2,155,588

PV of principal (P2,000,000 x 0.6499) 1,299,800

PV of interest [(P2,000,000 x 11%) x 3.8897] 855,734
Issue price 2,155,534

Question No. 36 - B
Carrying value, 1/1/05 (see no. 1) 2,155,534
Less premium amortization for 2005:
Nominal interest (P2,000,000 x 11%) 220,000
Effective interest (P2,155,534 x 9%) 193,998 26,002
Carrying value, 12/31/05 2,129,532

Question no. 37 - C
Retirement price 1,980,000
Carrying value, 12/31/06:
Carrying value, 1/1/06 (see no. 36) 2,129,532
Less premium amortization for 2006:
Nominal interest (P2,000,000 x 11) 220,000
Effective interest (P2,129,532 x 9%) 191,658 28,342 2,101,190
Gain early retirement of bonds 121,190

Question No. 38 - A
Carrying value, 7/1/05 (see below) 4,580,950
Add discount amortization, 12/1/05 to 5/31/05
Effective interest (P4,580,950 x 12% x 6/12) 274,857
Nominal interest (P5,000,000 x 10% x 6/12) 250,000 24,857
Carrying value, 12/31/05 4,605,807

Total proceeds 5,000,000

Less liability component:
Present value of the principal (P5,000,000 x 0.4970) 2,485,000
Present value of the interest [(P5,000,000 x 10% x 8.3838) 2,095,950 4,580,950
Equity component 419,050

Question No. 39 - B
Bonds Payable 1,500,000
Discount on bonds payable (P1,500,000 - P1,389,647) 110,353
Common stock 15,000
APIC 1,374,647

Carrying value of bonds converted (P4,632,155* x 1,500/5,000) 1,389,647

Par value of common stock issued (15,000 shares x P1) 15,000
Amount to be credited to APIC 1,374,647
Carrying value, 12/31/04 (see no. 38) 4,605,807
Add discount amortization for 2006:
Effective interest (P4,605,807 x 12% x 6/12) 276,348
Nominal interest (P5,000,000 x 10% x 6/12) 250,000 26,348
Carrying value, 7/1/06 4,632,155 *
Question No. 40 - B
PROBLEM NO. 8 - Geum Young Corporation

Common Retained Treasury

stock APIC earnings stock
Balances, 1/1/05 3,000,000 300,000 450,000 -
Issuance of CS, 6/15/05 5,000,000 1,000,000
Stock dividend, 9/30/05 400,000 40,000 (440,000)
Net income for 2005 475,000
Balances, 12/31/05 8,400,000 1,340,000 485,000 -
Acquisition of TS, 3/1/06 285,000
Sale of TS, 5/31/06 37,500 (142,500)
Exercise of 25,000 stock rights, 9/15/06 5,000,000 1,250,000
Exercise of 40,000 stock rights, 10/31/06 8,000,000 2,000,000
Declared cash dividend, 12/10/06 (425,000)
Retired 1,000 TS, 12/20/06 (100,000) 5,000 (95,000)
Net income for 2006 500,000
Balances, 12/31/06 21,300,000 4,632,500 560,000 47,500
41 - B 42 - C 43 - D 44 - B 45 - D
PROBLEM NO. 9 - Jang Duk, Inc.
2006
12.31.05 Transactions 12.31.06

Preferred stock 90,000 a 180,000 180,000 (46) A

e (90,000)
Common stock 1,650,000 b 67,500 1,717,500 (47) A
Subscribed common stock - d 150,000 150,000
Additional paid in capital - common - b 101,250 326,250 (48) B
d 225,000
Retained earnings - appropriated - 182,250 182,250
Retained earnings - unappropriated 933,000 e (18,000) 824,250 (49) B
f (36,000)
g (247,500)
h 375,000
(182,250)
Treasury stock - common - c (182,250) (182,250)
Discount on preferred stock - a (30,000) (30,000)
2,673,000 3,168,000 (50) D

Journal entries for 2006

a Land (at appraised value) 150,000

Discount on preferred stock 30,000
Preferred stock (12,000 shares x P15) 180,000
b Cash (6,750 shares x P25) 168,750
Common stock (6,750 shares x P10) 67,500
APIC - excess over par of common stock 101,250
c Treasury stock - common 182,250
Cash (6,750 shares x P27) 182,250

d Cash 292,500
Subscriptions rec. [(15,000 shares x P25)- P292,500] 82,500
Subscribed common stock (15,000 shares x P10) 150,000
APIC - excess over par of common stock 225,000
Note: Subscriptions receivable should be presented under currents assets
since it is currently collectible.

e Preferred stock (6,000 shares x P15) 90,000

Retained earnings 18,000
Cash (6,000 shares x P18) 108,000
f Retained earnings 36,000
Cash 36,000
Preferred shares issued and outstanding, 1/1/05 6,000
Shares issued, 1/31 12,000
Number of shares issued and outstanding, 10/15 18,000
Dividends per share 2.00
Total cash dividends 36,000
g Retained earnings 247,500
Dividends payable 247,500
Common shares issued and outstanding, 1/1/05 165,000
Shares issued, 2/14 6,750
Number of shares issued 171,750
Treasury shares (6,750)
Number of shares issued and outstanding, 10/15 165,000
Dividends per share 1.50
Total cash dividends 247,500
h Income summary 375,000
Retained earnings 375,000
Retained earnings 182,250
Retained earnings - appropriated (cost of TS) 182,250