CEBU CPAR CENTER. M a n d a u e C I t y

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1 Page 1 of 8 CEBU CPAR CENTER M a n d a u e C I t y AUDITING PROBLEMS AUDIT OF RECEIVABLES PROBLEM NO. 1 In the audit of Beatles Company, the auditor had an appreciation of the following schedule and noted some comments for possible adjustments: Beatles Company Accounts Receivable Schedule December 31, 2005 Customer Balance Current Past Due 1. Love M. Do P92,000 P - P92, Strawberry Fields 420, , , This Boy Company 350,000 92, , Girl Corporation 374, , , Ticket To Ride Transport Corp. 160, , Let It Be Corporation 124,000 60,000 64, Hey Jude 4,000 4, Get Back Company 256,000 80, , Yesterday Corporation 240, ,000 - Totals P2,020,000 P936,000 P1,084,000 The Accounts Receivable control account balance was determined to be P2,020,000. The external auditor submitted the following audit comments for possible adjustments: 1. Love M. Do Merchandise found defective; returned by customer on October 31, 2005 for credit, but the credit memo was issued by Beatles only on January 15, Strawberry Fields Account is good but usually pays late. 3. This Boy Company Merchandise worth P160,000 was destroyed while in transit on May 31, 2005, terms FOB Destination. The carrier was billed on June 15, (See Ticket To Ride Corp. and Yesterday Corp.) 4. Girl Corporation Customer billed twice in error for P40,000. Balance is collectible. 5. Ticket To Ride Transport Corp. Collected in full on January 31, Let It Be Corporation Paid in full on December 30, 2005 but not recorded. Collections were deposited on January 2, Hey Jude Received account confirmation from customer for P44,000. Investigation revealed an erroneous credit for P40,000. (See Get Back Company) 8. Get Back Company Neglected to post P40,000 credit to customer s account. 9. Yesterday Corporation Customer wants to know reason for receipt of P160,000 credit memo as their accounts payable balance was P400,000. REQUIRED: a. Adjusting entries as of December 31, b. Adjusted balance of Accounts Receivable - Trade as of December 31, 2005.

2 Page 2 of 8 PROBLEM NO. 2 The following information is based on the first audit of Paul Company. The client has not prepared financial statements for 2003, 2004, or During these years, no accounts have been written off as uncollectible, and the rate of gross profit on sales has remained constant for each of the three years. Prior to January 1, 2003, the client used the accrual method of accounting. From January 1, 2003 to December 31, 2005, only cash receipts and disbursements records were maintained. When sales on account were made, they were entered in the subsidiary accounts receivable ledger. No general ledger postings have been made since December 31, As a result of your examination, the correct data shown below are available: 12/31/ /31/2005 Accounts receivable balances: Less than one year old P61,600 P112,800 One to two years old 4,800 7,200 Two to three years old - 3,200 Over three years old - 8,800 P66,400 P132,000 Inventories 146, ,160 Accounts payable for inventory purchased 20,000 44,000 Cash received on accounts receivable in: Applied to: Current year sales P595,200 P647,200 P835,200 Accounts of the prior year 53,600 60,000 67,200 Accounts of two year prior 2,400 1,600 8,000 Total P651,200 P708,800 P910,400 Cash sales 68, , ,800 Cash disbursements for inventory purchased 750, , ,600 REQUIRED: Based on the above and the result of your audit, compute for the gross profit for the years ended December 31, 2003, 2004 and PROBLEM NO. 3 In your audit of the books of George Company for the year 2005, you concluded that the allowance for doubtful accounts should be adjusted to equal the estimated amount required based on aging of the accounts as of December 31. During your audit, you were able to gather the following data: Allowance for doubtful accounts, Jan. 1, 2005 P300,000 Provision for doubtful accounts during 2005 (3% of P5,000,000 sales) 150,000 Bad debts written off in ,500 Recovery of bad debts written off during ,000 Estimated doubtful accounts per aging of accounts on Dec. 31, ,000 Accounts receivable, December 31, ,375,000 REQUIRED: 1. Based on the result of your audit, determine the following: a. Doubtful accounts expense for b. Net realizable value of Accounts Receivable as of December 31, 2005.

3 c. The increase(decrease) in the recorded Allowance for doubtful accounts. d. Adjusting journal entry. 2. Assuming there was no aging of accounts, determine the following: a. Doubtful accounts expense for b. Allowance for doubtful accounts as of December 31, Page 3 of 8 3. Assuming there was no aging of accounts and the company used 8% percent of accounts receivable method, determine the following: a. Doubtful accounts expense for b. Allowance for doubtful accounts as of December 31, PROBLEM NO. 4 The John Corporation started its business on January 1, After considering the collections experience of other companies in the industry, John Corporation established an allowance for bad debts estimated to be 5% of credit sales. Outstanding receivables recorded in the books of accounts on December 31, 2005 totaled P575,000, while the allowance for bad debts account had a credit balance of P62,500 after recording estimated doubtful account expense for December and after writing off P12,500 of uncollectible accounts. Further analysis of the company s accounts showed that merchandise purchased in 2005 amounted to P2,250,000 and ending merchandise inventory was P375,000. Goods were sold at 40% above cost. 80% of total sales were on account. Total collections from customers, on the other hand, excluding proceeds from cash sales, amounted to P1,500,000. QUESTIONS: Based on the above and the result of your audit, answer the following: 1. The recorded accounts receivable as of December 31, 2005 is understated by a. P12,500 b. P412,500 c. P537,500 d. P0 2. The doubtful accounts expense for the year ended December 31, 2005 should be a. P105,000 b. P75,000 c. P131,250 d. P125, The recorded allowance for doubtful accounts receivable as of December 31, 2005 is understated by a. P50,000 b. P30,000 c. P56,250 d. P0 4. The net realizable value of accounts receivable as of December 31, 2005 is a. P495,000 b. P512,500 c. P993,750 d. P875,000 PROBLEM NO. 5 The accounts receivable subsidiary ledger of Ringo Corporation shows the following information: Dec. 31, 2005 Invoice Customer Account balance Date Amount Maybe, Inc. P140,720 12/06/05 11/29/05 P56,000 84,720 Perhaps Co. 83,680 09/27/05 08/20/05 48,000 35,680 Pwede Corp. 122,400 12/08/05 10/25/05 80,000 42,400 Perchance Co. 180,560 11/17/05 10/09/05 92,560 88,000 Possibly Co. 126,400 12/12/05 12/02/05 76,800 49,600 Luck, Inc. 69,600 09/12/05 69,600 Total P723,360 P723,360

4 Page 4 of 8 The estimated bad debt rates below are based on the Corporation s receivable collection experience. Age of accounts Rate 0 30 days 1% days 1.5% days 3% days 10% Over 120 days 50% The Allowance for Doubtful Accounts had a credit balance of P14,000 on December 31, 2005, before adjustment. QUESTIONS: Based on the foregoing, answer the following: 1. How much is the adjusted balance of the allowance for doubtful accounts as of December 31, 2005? a. P52,795 b. P24,795 c. P38,795 d. P14, The necessary adjusting journal entry to adjust the allowance for doubtful accounts as of December 31, 2005 would include: a. No adjusting journal entry is necessary. b. A debit to retained earnings of P24,795. c. A debit to doubtful accounts expense P38,795. d. A credit to allowance for doubtful accounts of P24,795. PROBLEM NO. 6 The balance sheet of Yoko Corporation reported the following long-term receivables as of December 31, 2004: Note receivable from sale of plant P6,000,000 Note receivable from officer 1,600,000 In connection with your audit, you were able to gather the following transactions during 2005 and other information pertaining to the company s long-term receivables: a. The note receivable from sale of plant bears interest at 12% per annum. The note is payable in 3 annual installments of P2,000,000 plus interest on the unpaid balance every April 1. The initial principal and interest payment was made on April 1, b. The note receivable from officer is dated December 31, 2004, earns interest at 10% per annum, and is due on December 31, The 2005 interest was received on December 31, c. The corporation sold a piece of equipment to Yes, Inc. on April 1, 2005, in exchange for an P800,000 non-interest bearing note due on April 1, The note had no ready market, and there was no established exchange price for the equipment. The prevailing interest rate for a note of this type at April 1, 2005, was 12%. The present value factor of 1 for two periods at 12% is d. A tract of land was sold by the corporation to No Co. on July 1, 2005, for P4,000,000 under an installment sale contract. No Co. signed a 4-year 11% note for P2,800,000 on July 1, 2005, in addition to the down payment of P1,200,000. The equal annual payments of principal and interest on the note will be P902,500 payable on July 1, 2006, 2007, 2008,and The land had an established cash price of P4,000,000, and its cost to the corporation was P3,000,000. The collection of the installments on this note is reasonably assured. QUESTIONS: Based on the above and the result of your audit, determine the following:

5 1. Noncurrent receivables as of December 31, 2005 a. P9,037,600 b. P6,500,484 c. P7,037,600 d. P6,443, Current portion of long-term receivables as of December 31, 2005 a. P2,000,000 b. P2,594,500 c. P2,902,500 d. P0 3. Accrued interest receivable as of December 31, 2005 a. P360,000 b. P514,000 c. P571,384 d. P674, Interest income for the year 2005 a. P854,000 b. P911,384 c. P1,091,384 d. P1,008,000 Page 5 of 8 PROBLEM NO. 7 On December 31, 2004, Ono Company finished consultation services and accepted in exchange a promissory note with a face value of P300,000, a due date of December 31, 2007, and a stated rate of 5%, with interest receivable at the end of each year. The fair value of the services is not readily determinable and the note is not readily marketable. Under the circumstances, the note is considered to have an appropriate imputed rate of interest of 10%. (Round-off present value factors to four decimal places) REQUIRED: 1. Consultation service fee revenue to be recognized 2. Carrying amount of the Note Receivable on December 31, Interest income for the year 2005 PROBLEM NO. 8 Select the best answer for each of the following: 1. In the audit of which of the following general ledger accounts will tests of controls be particularly appropriate? a. Equipment b. Bonds payable c. Bank charges d. Sales 2. An auditor most likely would review an entity s periodic accounting for the numerical sequence of shipping documents and invoices to support management s financial statement assertion of a. Existence or occurrence c. Valuation b. Rights and obligations d. Completeness 3. Which of the following might be detected by an auditor s review of the client s sales cut-off? a. Excessive goods returned for credit b. Unrecorded sales discounts c. Lapping of year-end accounts receivable d. Inflated sales for the year 4. Cut-off tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management s assertion of a. Presentation b. Completeness c. Rights d. Existence 5. The auditor finds situation in which one person has the ability to collect receivables, make deposits, issue credit memos and record receipt of payments. The auditor suspects the individual may be stealing from cash receipts. Which of the following audit procedures would be most effective in discovering fraud in this scenario? a. Send positive confirmations to a random selection of customers. b. Send negative confirmations to all outstanding accounts receivable customers. c. Perform a detailed review of debits to customer discounts, sales returns, or other debit accounts, excluding cash posted to the cash receipts journal. d. Take a sample of bank deposits and trace the detail in each bank deposit back to the entry in the cash receipts journal.

6 Page 6 of 8 6. Which of the following most likely would give the most assurance concerning the valuation assertion of accounts receivable? a. Vouching amounts in the subsidiary ledger to details on shipping documents. b. Comparing receivable turnover ratios with industry statistics for reasonableness. c. Inquiring about receivables pledged under loan agreements. d. Assessing the allowance for uncollectible accounts for reasonableness. 7. In confirming accounts receivable, an auditor decided to confirm customers account balances rather than individual invoices. Which of the following most likely would be included with the client s confirmation letter? a. An auditor prepared letter explaining that a non-response may cause an inference that the account balance is correct. b. A client prepared letter reminding the customer that a non-response will cause a second request to be sent. c. An auditor prepared letter requesting the customer to supply missing and incorrect information directly to the auditor. d. A client prepared statement of account showing the details of the customer s account balance. 8. Which of the following statements would an auditor most likely to add to the negative form of confirmations of accounts receivable to encourage timely consideration by the recipient? a. This is not a request for payment; remittances should not be sent to our auditors; in the enclosed envelope b. Report any difference on the enclosed statement directly to our auditors; no reply is necessary if this amount agrees with your records. c. If you do not report any difference within 15 days, it will be assumed that this statement is correct. d. The following invoices have been selected for confirmation and represent amounts that are overdue. 9. Auditing standards define a confirmation as the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions Two assertions for which confirmation of accounts receivable balances provides primary evidence are a. Completeness and valuation c. Rights and obligations and existence b. Valuation and rights and obligations d. Existence and completeness 10. Auditor may use positive or negative forms of confirmations requests for accounts receivable. An auditor most likely will use a. The positive form to confirm all balances regardless of the size. b. A combination of the two forms, with the positive form used for large balances and the negative for the small balances c. A combination of the two forms, with the positive form used for trade receivables and the negative form for other receivables. d. The positive form when the combined assessed level of inherent and control risk for assertions related to receivables is acceptably low, and the negative form when it is unacceptably high. 11. The negative request form of accounts receivable confirmation may be used when the Combined Assessed Level Of Inherent and Control Risk Is Number of Small Balances is Consideration by the Recipient is a. Low Many Likely b. Low Few Unlikely c. High Few Likely d. High Many Likely 12. In the confirmation of accounts receivable, the auditor would most likely a. Request confirmation of a sample of the inactive accounts b. Seek to obtain positive confirmations for at least 50% of the total dollar amount of the receivables. c. Require confirmation of all receivables from agencies of the federal government. d. Require that confirmation requests be sent within 1 month of the fiscal year-end.

7 Page 7 of Negative confirmations of accounts receivable is less effective than positive confirmation of accounts receivable because a. A majority of recipients usually lack the willingness to respond objectively. b. Some recipients may report incorrect balances that require extensive follow-up. c. The auditor cannot infer that all non-respondents have verified their account information. d. Negative confirmations do not produce evidence that is statistically quantifiable. 14. To reduce the risks associated with accepting fax responses to request for confirmation of accounts receivable, an auditor most likely would a. Examine the shipping documents that provide evidence for the existence assertion. b. Verify the sources and contents of the faxes in telephone calls to the senders. c. Consider faxes to the non-responses and evaluate them as unadjusted differences. d. Inspect the faxes for forgeries or alterations and consider them to be acceptable if none are noted. 15. An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents exceptions and comments. By this procedure, the auditor is most likely to learn of which of the following? a. One of the cashiers has been covering a personal embezzlement by lapping. b. One of the sales clerks has not been preparing charge slips for credit sales to family and friends. c. One of the computer processing control has been removing all sales invoices applicable to this account from the data file. d. The credit manager has misappropriated remittances from customers whose accounts have been written off. 16. An auditor who has confirmed accounts receivable may discover that the sales journal was held open past year-end if a. Positive confirmations sent to debtors are not returned b. Negative confirmations sent to debtors are not returned c. Most of the returned negative confirmations indicate that the debtor owes a larger balance that the amount being confirmed. d. Most of the returned positive confirmations indicate that the debtor owes a smaller balance than the amount being confirmed. 17. During the process of confirming accounts receivable as of December 31, 2005 a positive confirmation was returned indicating the balance owed as of December 31, 2005 was paid on January 9, The auditor will most likely a. Determine whether there were any changes in the account between January 1 and January 9, b. Determine whether a customary trade discount was taken by the customer. c. Reconfirm the zero balances as of January 10, d. Verify that the amount was received. 18. Confirmation of accounts receivable is a generally accepted auditing procedure. The presumption that an auditor will confirm accounts receivable is not overcome if a. Based on prior s years audit experience response rates will be inadequate. b. Based on experience with similar engagements, responses are expected to be unreliable. c. The accounts receivable are immaterial. d. The combined assessed level of inherent and control risk is high. 19. A company has computerized sales and cash receipts journals. The computer programs for these journals have been properly debugged. The auditor discovered that the total of the accounts receivables subsidiary accounts differs materially from the accounts receivable control account. This discrepancy could indicate a. Credit memoranda being improperly recorded. b. Lapping of receivables c. Receivables not being properly aged. d. Statements being intercepted prior to mailing.

8 Page 8 of Which of the following procedures would an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies to second requests? a. Review the cash receipts journal for the month prior to year-end. b. Intensify the study of internal control concerning the revenue cycle. c. Increase the assessed level of detection risk for the existence assertion d. Inspect the shipping records documenting the merchandise sold to the debtors. 21. Which of the following is the greatest drawback of using subsequent collections evidenced only by a deposit slip as an alternative procedure when responses to positive accounts receivable confirmations are not received? a. Checking of subsequent collections can never be used as an alternative auditing procedure. b. By examining a deposit slip only, the auditor does not know whether the payment is for the receivable at the balance sheet date or a subsequent transaction. c. A deposit slip is not received directly by the auditor. d. A customer may not have made a payment on a timely basis. 22. The CPA learns that collections of accounts receivable during the last 10 days of December were not recorded. The effect will be to a. Leave both working capital and the current ratio unchanged at December 31. b. Overstate both working capital and the current ratio at December 31. c. Overstate working capital with no effect on the current ratio at December 31. d. Overstate the current ratio with no effect on working capital at December All of the following are examples of substantive tests to verify valuation of net accounts receivable except the a. Re-computation of the allowance for bad debts. b. Inspection of accounts for current versus non-current status in the statement of financial position. c. Inspection of the aging schedule and credit records of past due accounts. d. Comparison of the allowance for bad debts with past records. 24. Once a CPA has determined that the accounts receivable have increased because of slow collections in a tight money environment, the CPA is likely to a. Increase the balance in the allowance for bad debts account b. Review the going concern ramifications. c. Review the credit and collection policy. d. Expand tests of collectibility. 25. An auditor reconciles the total of the accounts receivables subsidiary ledger to the general ledger control account as of October 31. By this procedure, the auditor is most likely to learn of which of the following? a. An October invoice was improperly computed. b. An October check from a customer was posted in error to the account of another customer with a similar name. c. An opening balance is a subsidiary ledger account was improperly carried forward from the previous accounting period. d. An account balance is past due and should be written off. End of

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