Solution with answer applied auditing by cabrera chapter10

CHAPTER

10

SUBSTANTIVE TESTS OF
INVESTMENTS

10-1.

The CPAs would accept a confirmation of the securities on hand from the
custodian in lieu of their personal inspection of the securities after they had
investigated and satisfied themselves as to the standing of the custodian. The
CPAs would probably be satisfied if they found the custodian to be a well-known,
reliable financial institution, completely independent of the client and with
resources substantially larger in amount than the securities of the CPAs’ client that
are on deposit.

10-2.

The auditors can make an independent computations of dividends earned during
the year by reference to dividend record books published by investment advisory
services.

10-3.

Securities owned by the client may not be on hand at the balance sheet date
because they are held by others for safekeeping, pledged as collateral for loans,
deposited as assurance of performance under contracts, or in the hands of brokers
or others for transfer.

10-4.

When the inspection of securities cannot be made for two weeks after the balance
sheet date, the client at the auditors’ suggestion may instruct the bank that the safe
deposit box is not to be opened until the time of the auditors’ inspection. A letter
may be obtained from the bank stating that the box has not been opened between
the balance sheet date and the auditors’ arrival. If the securities are in the client’s
office, it will be necessary to verify any security transactions between the date of
inspection and the balance sheet date and to reconcile the results of the inspection
with the securities owned at the balance sheet date. The count of cash and other
negotiable assets should be coordinated with the inspection of securities.

10-5.

Pink Corporation
(a) Instructions to be given to the assistant regarding the examination of the
securities kept in the safe deposit box include the following:
(1) A copy of the client’s record of the contents of the box should be
obtained and used in connection with the inspection of the securities.
Comparing the contents of the box and the record will provide assurance
that all securities listed in the record are on hand. (The validity of the
record will be determined by examination of the transactions pertaining
to investments.) The copy of the record, after being verified, should be
added to the auditors’ working papers as evidence of work performed.


10-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition
(2) The bank’s record of persons entering the deposit box should be
examined to determine that only authorized persons have had access to

the box and that there was no entry to the box between December 31 and
January 11. Entry to the box between those dates may be an indication
that a security was returned to safekeeping after being “borrowed” at
year-end. The security may have been “borrowed” and used as collateral
to obtain cash to cover a shortage at December 31.
(3) The assistant should be instructed to insist that the treasurer be present
while the securities are being examined. Most auditors prefer to obtain a
signed statement that all investments inspected were returned at the
completion of the inspection made in the presence of the custodian. In
any event, the working papers should note the date of the inspection and
the name of the witness to the inspection.
(4) The following details of the securities should be examined:
a) The name of the registered owner appearing on each security other
than bearer bonds should be noted to determine that Pink
Corporation is a registered owner and that securities belonging to
another owner have not been substituted.
b) The name of the corporation issuing the security and the class of the
security (Class A, Par Value, 1st Preference, etc.) should be noted for
assurance that a lower priced security (perhaps somewhat similar in
corporate name or a different security of the issuing corporation) has
not been substituted for a higher priced security.
c) The face value of bonds and the number of shares represented by
each share certificate should be compared with the client record to
determine that the entire amount of the corporation’s holdings of
each security is on hand.
d) The serial numbers of the securities should be compared with those
on the record and, for those securities carried over from the prior
year, compared with the serial numbers of securities listed in the
prior year’s working papers. A change in serial numbers that cannot
be properly explained may be an indication of manipulation of the

securities. Verification of serial numbers also helps establish the cost
of securities sold under either the FIFO or specific identification cost
method.
e) The certificates should be read to ascertain the interest rates and
payment dates for bonds and the dividend rates and payment dates, if
given, for preference shares. This information may be used later in
the verification of investment revenue.
f) Bonds should be examined to determine maturity dates. Maturity
dates are needed for verifying the computation of the amortization of
bond premiums or discounts. In addition, the maturity dates will
disclose whether any bonds on hand have matured. The presence of
matured bonds may be a sign of internal control weakness or may
indicate that the bonds are in default.


Substantive Tests of Investments

10-3

g) Coupon bonds should be inspected to determine that no past-due
interest coupons are unclipped and all future interest coupons are
attached. The presence of past-due coupons may be caused by poor
internal control and may indicate an understatement of interest
revenue. On the other hand, past-due coupons may indicate the
interest is in default and that the principal is uncollectible. Missing
future interest coupons may be an indication of an irregularity.
h) The auditors should be alert for any obvious alterations to securities
or forged certificates. Although auditors usually are not held
responsible for the genuineness of the certificates, any apparent
forgeries (or exceptions noted in the foregoing audit procedures)

may point out the need for obtaining confirmations from the
corporations issuing the certificates.
(b) The treasurer’s entry into the safe deposit box on January 4 has violated
the auditors’ control over negotiable assets which must be inspected or
counted simultaneously or kept under control until counted to avoid the
substitution of a counted asset for an uncounted asset in an attempt to
conceal a shortage. The auditors would probably apply the following
additional procedures:
(1) Reconcile bank balances at both year-end and at the date of
inspecting securities.
(2) Obtain a bank confirmation as of the inspection date.
(3) Examine cash journals between year-end and the inspection date for
any unusual entries.
(4) Examine all investment transactions taking place between the
balance sheet date and the inspection date to verify the amount of the
investment at the balance sheet date.
(5) If the client keeps a large fund of cash on hand, make a surprise
count of the cash fund.
(6) Review the transactions since year-end relating to any other
negotiable assets, such as notes receivable, to determine if any
substitutions have been made.
10-6.

(a) (4) Having the securities held in safekeeping by a bank provides strong
internal control because the bank has no direct contact with the
employees responsible for maintaining the accounting record of the
securities and that individual has no access to the securities. Thus the
separation of the custody of securities from the accounting function is
complete.
(b) (1) The investment committee of the board of directors is not involved in the

routine of making buy and sell decisions and can therefore review the
transactions objectively. On the other hand, the chief operating officer,
the controller, and the treasurer may be closely associated on a daily
basis with the financial executive responsible for the investment
decisions.


10-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition

10-7.

Voltron Company
Voltron Company
Marketable Securities
12.31.06
Balance, 1.1.06
Lie Company, 25 shares @ P42
Lipay Company, 20 shares @ P65
Add: Purchase of Lambing Co., 5% bonds, 5 shares
Total
Less: Sale of 10 shares of Lipay Co., stocks
Sale of 5 shares of Lambing Co., bonds
Balance per ledger, 12.31.06
Add (Deduct) Adjustment(s)
AJE (1) To correct error in recording purchase
of Lambing Co., bonds
(2) To correct error in recording sale of
Lipay Co., stocks

(3) To correct error in recording sale of
Lambing Co., bonds
Net
Balance as adjusted
Lie Co., 25 shares @ P42
Lipay Co., 15 shares @ P52

P2,350.00
4,762.50
P7,112.50
P 650.00
4,762.50

5,415.50
P1,700.00
( 62.50)
130.00
62.50
130.00
P1,830.00

P1,050.00
780.00
P1,830.00

Adjusting Journal Entries:
(1) Interest income
Marketable securities – Trading
(2) Marketable securities – Trading
Gain on sale of marketable securities

Proceeds ( 10 x P65 )
Cost: ( 10 x P1,300 )
25
Gain
(3) Marketable securities – Trading
Interest income
(4) Securities fair valued adjusted – Trading
Unrealized gain on trading securities (P/L)
Lie Co. (P45 – P42) (25 shares)
Lipay Co. (P55 – P52) (15 shares)

62.50
62.50
130.00
130.00
P 650.00
520.00
P 130.00
62.50
62.50
120.00
120.00
P 75
45
P120


Substantive Tests of Investments
10-8.

10-5

Color Company

Requirement (a)
COLOR COMPANY
Investment
12.31.06

Description

Red Company, ordinary
Purchased in June 1993 @ P20
Purchased in Aug. 1996 @ P16
Purchased in May, 2004 @ P22
White Company, ordinary
Purchased in Jan., 2004 @ P33
Purchased in March, 2006
Blue Company, ordinary
Purchased in Aug., 1995 @ P13
Green Company, 15% bonds
Purchased in July, 1998

Total

Balance 1.1.06
No. of
Shares
Amount

1,000
2,000
1,500

P 20,000
32,000
33,000
85,000

2,000

66,000
________
66,000

100
20

7,300
20,000

P178,300

Changes during the year
No. of Shares
Amount
Acquire
d

Sold

Acquired

1,000

500
100 SD

Sold

P 21,364

P12,125
100

10,000

20

8,750
22,500

P 22,125

P 52,614

Balance 12.31.06
No. of
Shares
Amount

1,000
2,000
500

P 20,000
32,000
11,636

2,000
500

66,000
12,125

100

8,550
( 2,500)

P147,811

Adjustments

Balance

Dr (Cr)

As
Adjusted

(1)

( 636)

P 20,000
32,000
11,000
63,000
66,000
12,125
78,125

(2) (10,000)
(3) 5,100
(4)

2,500

P(3,036)

3,650
-

P 144,775


10-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition

10-8.

Color Company (continued. . . . .)
Requirement (b) Adjusting Journal Entries
AJE (1)
(2)
(3)

(4)

(5)

Loss on sale of investment
Investment
Dividend income
Investment

636
636
10,000
10,000

Accounts receivable - President
Investment
Gain on sale of investment

3,750
5,100

Investment
Gain on sale of investment
Interest income

2,500

Securities fair value adjusted – Trading
Unrealized gain in trading securities
– (P/L)

5,225

8,850
2,000
500

5,225


Substantive Tests of Investments
10-9.

10-7

Kalayaan Corporation
The Kalayaan Corporation
Investments
December 31, 2006

Per Books

Date
2006
Jan. 3
5

Transactions

Dr

Purchased 100 shares, National Motors
Purchased 100 shares, Major Electronics

P 4,500
500

Mar. 31

Cash dividend, National Motors

Apr.

Sold 100 shares, National Motors
Purchased 100 shares, Ace Investment
Purchased 100 shares, General Utility

5
6
6

50

4,800

(2)

300

(4)

100

2
15
18

Purchased 10 shares, General Utility
Purchased 50 shares, Acme Laboratories
Purchased 20 shares, The Kalayaan Corp.

130
1,900
3,000

Aug. 15

Sold 10 shares, The Kalayaan Corporation

Dec. 8

Received 2 shares, Acme Laboratories

(5)

60

(7) 1,550

80

(8)
20

(9)

2

90

(10)

80

120

_______
15,030

P 15,030

(4,500)

2,300
2,280

(6) 3,000
1,550

Cash dividend, Acme Laboratories

P 4,500
-

120

July

Balance

(1)

(3)

100

Cash dividend, Ace Investment
Cash dividend, General Utility

50

2,300
2,400

Received 100 rights issues, General Utility

15
31

As Adjusted
Dr (Cr)

(13) 500
P

May 1

8

I N V E S T M E N T
Adjustments
Cr
Dr
Cr

80

_______
6,510

________
2,04
2

8,520

1,87
8

P 15,030

P 3,920

(1)

Gain on sale of investment

Miscellaneous income

(4) 100

190
1,900
-

Investment in rights issues

-

Treasury shares

-

Additional paid on Capital TS trans.
Gain on sale of fractional
shares
Dividend income
Miscellaneous income
Dividends receivable
Dividend income
Loss on expiration of rights
issues
Investment in rights issues

18)
10)
-

(5)

3,920

(7) 1,500
(7)
(9)

(10) 80
(12) 110
(14) 60
(14) 60

Adjusting Journal Entry

SAS (Equity)

50
2

(11) 120
(12) 110

________

P 6,642

60

(6) 3,000

Unrealized holding loss on
P

50

(2) 300

-

Treasury shares

Cr

(13) 500

(3) 120

(

________
3,920

Loss on investment on
Major Electronics
Dividend income

Investment in rights issues

(
(11) 120

Adjustments to Other Accounts
Name of Account
Dr

(15) 1,142


Substantive Tests of Investments
Securities Fair Value
Adjustment – SAS

10-8
(15) 1,142

10-9

Solutions Manual to Accompany Applied Auditing, 2006 Edition

10-10.

Canada Corporation
Note to Instructor: This problem contains petty cash journal entries and a bank
reconciliation, previously covered in Chapter 7.
Requirement (1)
2005
Jan. 1

Feb. 1

1
28
28

28

Investment in Available-for-Sale Securities
[(150 x P20)] + (200 x P30) + (100 x P25)]
Cash
Investment in Available-for-Sale Securities
(P20,000 + P12,000)
Interest Revenue [(P20,000 x 0.12 x 5/12)
+ (P12,000 x 0.10 x 4/12)]

Cash
Petty Cash
Cash
Cash
Interest Revenue [P20,000 x 0.12 x 6/12]
Postage Expense
Office Supplies Expense
Transportation Expense
Miscellaneous Expense
Cash
Cash Short and Over
Cash
a

Mar. 31

31

31

11,500.00
32,000.00
1,400.00
33,400.00
500.00
500.00
1,200.00
1,200.00
110.00
170.65

45.00
43.50
369.15
5.35

a

5.35

P125.50 – (P500.00 – P369.15)

Cash (P1,500 + P600)
Interest Receivable (P20,000 x 0.12 x 1/12;
A Co. bonds)
Dividend Revenue
Interest Revenue [(P12,000 x 0.10 x
6/12) + (P20,000 x 0.12 x 1/12)]
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities
Allowance for Change in Value of
Investment
b

11,500.00

2,100
200
1,500
800
900.00

900b

P42,600 – (P11,500 – P32,000)

Postage Expense
Office Supplies Expense
Miscellaneous Expense
Cash

140.00
75.30
54.20
269.50


10-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (2)
CANADA CORPORATION
Bank Reconciliation
March 31, 2005
Balance per bank statement
Add:
Deposits in transit

P13,459.75
2,100.00
P15,559.75
(2,365.40)

P13,194.35

Deduct: Outstanding checks
Adjusted cash balance
Balance per company records
Add:
Note collected by bank
Interest on note
Deduct: Bank service charge
NSF check returned
Adjusted cash balance

P11,689.95
P1,500.00
100.00
P

20.00
75.60

1,600.00
P13,289.95
(95.60)
P13,194.35

Requirement (3)
2005
Mar. 31

31

10-11.

Cash
Notes Receivable
Interest Revenue
Miscellaneous Expense
Accounts Receivable
Cash

1,600.00
1,500.00
100.00
20.00
75.60
95.60

Patrick Company
1.
P10,000
P30,000
P630,000

dividend revenue for 2005 (10,000 shares x P1.00)
12/31/05 unrealized increase in value of available-for-sale securities
[10,000 x (P63 – P60)]
12/31/05 carrying value of investment (10,000 shares x P63 market
price)

2.

P40,000
P110,000
P2,626,000

investment income for 2005 (P400,000 net income x 0.10
ownership)
investment income for 2006 [(P300,000 x 0.10) + (P200,000 x
0.40)]
12/31/06 carrying value [P650,000 a + P1,950,000 cost + P80,000
investment income for second half of 2006 – P54,000 dividends
(40,000 x P1.35; 10/1/06)]
a

P1,950,000 ÷ 30,000 shares = P65
P65 x 10,000 = P650,000


Substantive Tests of Investments
10-12.

10-11

Belle Manufacturing Corporation
a.

The auditing objectives and procedures relative to the Laribee Investment
account are as follows:
(1) Objective: Ascertain that the shares exist and are owned by Belle.
Procedures: Examine the shares for existence and ownership.
(2) Objective: Establish correctness of beginning balance in investment

account.
Procedures: Examine last year’s audit work papers.
(3) Objective: Determine proper approval of the 2006 purchase.
Procedures: Examine directors’ minutes authorizing the transaction.
(4) Objective: Establish the cost of shares purchased in 2006.
Procedures: Examine brokers’ advice and canceled check.
(5) Objective: Determine that the proper amount of dividends were
received, properly recorded as a decrease in the investment carrying
value, and deposited in the bank.
Procedures: Refer to a dividend reporter (e.g., Standard and Poors),
recalculate Belle’s share of the dividend, trace to remittance advice and
bank statement, and examine journal entry for proper recording.
(6) Objective: Ascertain in that Belle has properly recorded its shares of
Laribee income as an increase in the investment account.
Procedures: Examine Laribee’s income statement and Belle’s journal
entry, if any, to record its share of the income.

b.

If this investment is significant in relation to Belle’s total assets, and/or its
share of Laribee income is significant relative to Belle’s total income, Flores
must insist that the financial statements of Laribee be audited, either by
Castro & Horario, or by other independent CPAs.

c.
Belle Manufacturing Company
Investment in Laribee Industries
December 31, 2006
No. of Shares
12/31/06:

1/2/07:

Final balance - 1,000 shares
Purchased 1,500 shares

P 50,000
75,000

12/31/07:

Ledger balance
AJE No. 1

125,000
210,000

12/31/07:

Audited balance

P335,000
To WP–H

<
* @

1,000
1,500
2,500
_____

2,500 &


10-12

Solutions Manual to Accompany Applied Auditing, 2006 Edition
AJE 1
Investment in Laribee Ordinary
P210,000
Dividend Revenue
40,000
Equity in Income of Unconsolidated
Subsidiary
To adjust investment account for excess
of Belle’s share of Laribee income over
Laribee dividends.
Dividends:
4/1/07
7/1/07
10/1/07
Income:
25% of P1 million
<
*
&
“
#
X
d.

P250,000

(P
(P
(P
(P

12,500) “ #
12,500) “ #
15,000) “ #
40,000)

P250,000 X
P210,000

Compared with 12/31/06 work papers.
Vouched to broker’s advice and canceled check.
Examined minutes for directors’ authorization.
Recalculated.
Traced to remittance advice, cash receipts record, and bank statement.
Examined audited income statement.

Flores should be aware of the possible existence of related party transactions
between Belle and Laribee. In this regard, she should be particularly alert to
possible disparities between the legal form of transactions and their economic
substance. For example, Belle manufactures earth moving equipment and
Laribee is a leasing company. Significant sale and leaseback transactions
may have occurred given the nature and relationship of the respective
companies. If these transactions did take place, Flores must ascertain that any
gains on sale of equipment have been deferred. Also, given the equity

method of accounting, Flores must determine that any intercompany profits
resulting from transactions between Belle and Laribee have been eliminated.
Finally, cases abound in which parent companies have “manufactured”
earnings by fabricating or misrepresenting transactions with subsidiaries. For
this reason, Flores must be alert to this possibility, and should carefully audit
all significant transactions between the two companies.


Substantive Tests of Investments
10-13.

10-13

Analen, Inc.
Requirement (1)
Analen, Inc.
Income Before Income Taxes from Investment in Bel Company
For the Year Ended December 31, 2006
October 1, 2006: Dividends received from
Bel Company (10,000 shares x P0.90)

P 9,000

Requirement (2)
Analen, Inc.
Income Before Income Taxes From Investment in Bel Company
For the Years Ended December 31, 2007, and 2006, Restated
Equity in earnings of Bel Company (Schedule 1)

10-14.

2007
P110,000

2006 Restated
P 40,000

Schedule 1: Equity in Earnings of Bel Company
Year ended December 31, 2006 (P400,000 x 10%)

P 40,000

Year ended December 31, 2007
Six months ended June 30, 2007 [P300,000
(P500,000 - P200,000) x 10%]
Six months ended December 31, 2007 (P200,000 x 40%)
Total

P 30,000
80,000
P110,000

Elmar Company
Requirement (1)
July 2005: purchase of investment in trading security:
Investment in trading security: Celebrity Corp. bonds
(P1,000 x 8 x 1.02).................................................
Interest receivable (P8,000 x 9% x 2/12;
May 1 – July 1).......................................................
Cash.................................................................

8,160
120
8,280

Requirement (2)
November 2005 - Interest collected:
Cash (P8,000 x 9% x 6/12)..........................................
Interest revenue......................................................
Interest receivable...................................................

360
240
120


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Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (3)
Dec. 31, 2005: accrue interest on the Celebrity Corp. bonds held
as a trading securities investment:
Interest receivable (P8,000 x 9% x 2/12, Nov. – Dec.).
120
Interest revenue......................................................

120

Dec. 31, 2005: record fair value:
Unrealized loss on investment in trading securities

(close to Income summary).......................................
Valuation allowance: Celebrity Corp. bonds*.........

340

340

* Investment in Bonds:
Original cost............................................................
Fair value................................................................
Unrealized loss........................................................
Previously recorded unrealized loss.........................
DR<CR> to valuation allowance.............................

P8,000
7,760
P 240
0
P 240

Requirement (4)
Income Statement for 2005:
Interest revenue (P200 + P100)....................................
Unrealized loss on investment in trading securities......
Balance sheet at Dec. 31, 2005:
Current assets: Interest receivable...............................
Investments in trading securities..................................
Less: Allowance to reduce to fair value.......................
Investments in trading securities, at fair value..............
10-15.

P 300
<240>
P 120
P8,000
240
P7,760

Jeng Company
Requirement (1) Equity method
January 1, 2004 – Acquisition of long-term investment:
Investment in equity-basis company: Zash Corp......... 153,000
Cash [(30,000 x 0.30 = 9,000 shares) x P17]...........
During 2004 – Dividends declared and paid by Zash Corp.:
Cash (P8,000 x 0.30).................................................
Long-term investment in equity-basis company:
Zash Corp............................................................

153,000

2,400
2,400


Substantive Tests of Investments

10-15

December 31, 2004 – To recognize proportionate part of Zash Corp.
income:

Long-term investment in equity-basis company:
Zash Corp.................................................................
6,600
Investment income: equity in earnings of
associated company (P24,000 x 0.30)...................

6,600

December 31, 2004 – To recognize additional depreciation expense:
Investment income: equity in earnings of
associated company.................................................
600
Long-term investment in equity-basis company:
Zash Corp............................................................

600

Computation:
(P220,000 – P200,000) = P20,000; (P20,000 x 0.30)
÷ 10 yrs. = P600
December 31, 2004 – To recognize additional cost of goods sold:
Investment income: equity in earnings of
associated company.................................................
3,000
Long-term investment in equity-basis company:
Zash Corp............................................................

3,000

Computation:

[(P260,000 – P250,000) = P10,000] x 0.30 = P3,000
During 2005 – Dividends declared and paid by Zash Corp.:
Cash (P5,000 x 0.30).................................................
Long-term investment in equity-basis company:
Zash Corp............................................................
December 31, 2005 – To recognize Zash loss:
Investment income: equity in earnings of
associated company (P10,000 x 0.30)......................
Long-term investment in equity-basis company:
Zash Corp............................................................
December 31, 2005 – To recognize additional depreciation:
Investment income: equity in loss of
associated company.................................................
Long-term investment in equity-basis company:
Zash Corp............................................................

1,500
1,500

3,000
3,000

600
600


10-16

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Requirement (2)
January 1, 2006 – To record sale of 500 shares of Zash shares:
Cash [(500 shares x P18), Zash Corp...........................
9,000
Long-term investment in equity-basis company:
Zash Corp............................................................
Gain on disposal of long-term securities..................

8,250
750

Computation:
Balance in investment account (P153,000 + P6,600 –
P2,400 – P600 – P3,000 – P1,500 – P3,000 – P600) . . .
= P140,500.
P148,500 x 500/9,000 shares = P8,250
Requirement (3)
2004
Income statement:
Investment income (loss)
(P6,600– P600 – P3,000)...................... P3,000
Gain (loss) on disposal.............................
0
Balance sheet:
Investment in equity-basis company
(P153,000 + P6,600 – P2,400
- P600 – P3,000)...................................
P153,600

(-P3,000– P600).......................

2005

2006

(3,600)
0

*
P750

(P153,600 – P1,500 – P3,000
– P600)..............................
P148,500

* Investment income for 2006 is not known, as no data are given for this year.

10-16.

Del Corporation
Requirement (1)
Assuming “other income” is zero, then the entire P74 million for 2006 and the
P127 million for 2005 are equity in the income of affiliated companies:

Equity in income of affiliated companies.....................................
Less: Undistributed equity in income of affiliated companies......
Maximum amount of dividends that could be received................

2006
P 74

27
P 47

2005
P127
84
P 43

If dividends were zero, then all of the equity in income of affiliated companies
would be retained. Since the amount actually retained was P27 million, the
amount of other income is P74 million less P27 million, or P47 million.


Substantive Tests of Investments

10-17

Requirement (2)
Investment at December 31, 2006.........................................
Investment at December 31, 2005.........................................
Increase in investment in equity............................................
Amount of increase resulting from undistributed equity
in income of affiliated companies..................................
Amount of increase (decrease) in investment from other
sources...........................................................................

P1,456
1,332
P 124
27

P

97

It appears Del either increased its equity holdings in its affiliated companies, or
made “advances” which had been recorded in the Investments account.
Requirement (3)
Rate of return on average investment in equity-basis companies = P74 / ([P1,332 +
P1,456] / 2) = 0.053%
Requirement (4)
If the investment at equity represents a 50% owned joint venture with no goodwill
or adjustment for book value to fair value of net assets, the total shareholders’
equity (TSE) can be approximated as:
Investment in Affiliate, at equity
TSE of Affiliate

=
=

50% x TSE of Affiliate Joint Venture
P1,456 / 0.50 = P2,912 million.

Knowing the percentage owned allows estimates of the net assets of the equitybasis companies to be made, assuming there are no adjustments or goodwill
involved.
10-17.

BYDG Company
(a) Securities Fair Value Adjustment—Trading.........
Unrealized Holding Gain or Loss—
Income.....................................................

(b) Securities Fair Value Adjustment—
Available-for-Sale............................................
Unrealized Holding Gain or Loss—
Equity.......................................................

5,000
5,000
5,000
5,000

(c) The Unrealized Holding Gain or Loss—Income account is reported in the
income statement under Other Revenues and Gains. The Unrealized Holding


10-18

10-18.

Solutions Manual to Accompany Applied Auditing, 2006 Edition
Gain or Loss—Equity account is reported as a part of other comprehensive
income and as a component of shareholders’ equity until realized. The
Securities Fair Value Adjustment account is added to the cost of the
Available-for-Sale or Trading Securities account to arrive at fair value.
Troy Company
(a) December 31, 2006
Unrealized Holding Gain or Loss—Income.........
Securities Fair Value Adjustment (Trading)...

1,400
1,400

(b) During 2007
Cash....................................................................
Loss on Sale of Securities....................................
Trading Securities.........................................

9,400
600
10,000

(c) December 31, 2007
Securities
Eric Corp. shares
Brad Co. shares
Total of portfolio
Previous securities fair value
adjustment balance—Cr.
Securities fair value
adjustment—Dr.

Cost
P20,000
20,000
P40,000

Fair Value
P19,100
20,500
P39,600

Securities Fair Value Adjustment (Trading).........
Unrealized Holding Gain or Loss—
Income.....................................................
10-19.

Unrealized
Gain (Loss)
(P (900)
( 500)
( (400)
( (1,400)
(P1,000)

1,000
1,000

Francis Corporation
The unrealized gains and losses resulting from changes in the fair value of
available-for-sale securities are recorded in an unrealized holding gain or loss
account that is reported as other comprehensive income and as a separate
component of shareholders’ equity until realized. Therefore, the following
adjusting entry should be made at the year-end:
Unrealized Holding Gain or Loss—Equity.................
Securities Fair Value Adjustment
(Available-for-Sale).........................................

8,000
8,000

Unrealized Holding Gain or Loss—Equity is reported as other comprehensive

income and as a separate component in shareholders’ equity and not included in


Substantive Tests of Investments

10-19

net income. The Securities Fair Value Adjustment (Available-for-Sale) account is a
valuation account to the related investment account.