Solution with answer applied auditing by cabrera chapter11

CHAPTER

11

SUBSTANTIVE TESTS OF PROPERTY,
PLANT AND EQUIPMENT

11-1.

Factors which facilitate the auditors’ verification of plant and equipment but are
not applicable to audit work on current assets include the following:
(a) High peso amount of individual items. A relatively few transactions may
support a large balance sheet amount.
(b) Usually little change in property accounts year to year. Land, buildings, and
equipment often remain unchanged for many years; hence there is little
accounting activity to verify. In contrast, such current assets as accounts
receivable and inventory may have a complete turnover several times a year.
(c) Minor effect on net income from cutoff errors. Cutoff errors in recording
transactions in plant and equipment are much less likely to have a material
effect on net income than are errors in the cutoff of transactions for purchase
and sale of merchandise. For example, a cutoff error which causes a
P30,000 year-end sales transaction to be recorded a day prior to shipment
may cause a P30,000 overstatement of the current year’s pretax income.

11-2.

The auditors must question the service lives adopted by the client for plant assets.
To do otherwise would be to fail in the collection of sufficient competent evidence
for the client’s depreciation policies and procedures.

11-3.

The principal objective of the auditors in analyzing a Maintenance and Repairs
expense account is to disclose any capital expenditures which were erroneously
recorded as expense.

11-4.

Documentary evidence usually available in the client’s office to substantiate legal
ownership of property, plant, and equipment includes deeds, policies of title
insurance or abstract of title and an attorney’s opinion as to title, property tax bills,
insurance policies, purchase contracts, purchase orders, invoices, and paid checks.
The auditors may also secure written representations from the client as to
ownership of these assets.

11-5.

The auditors employ the following substantive tests to detect unrecorded
retirements of property, plant, and equipment:
(a) If major additions of plant and equipment have been made during the year,
ascertain whether old equipment was traded in or superseded by the new
units.
(b) Analyze the Miscellaneous Revenue account to locate any cash proceeds
from sale of plant assets.


11-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition
(c) If any of the company’s products have been discounted during the year,
investigate the disposition of plant facilities formerly used in manufacturing

such products.
(d) Inquire of executives and supervisors whether any plant assets have been
retired during the year.
(e) Examine retirement work orders or other source documents for authorization
by the appropriate official or committee.
(f) Investigate any reduction of insurance coverage to see whether this was
caused by retirement of plant assets.

11-6.

Kris Corporation
(a) This is the first audit of Kris Corporation by Ian and Ronna. Moreover, the
company has not been audited by other public accountants during the two
previous years of operation. Under these circumstances, the auditors must
investigate fully transactions relating to plant and equipment during the two
prior years of the company’s existence, as well as the records of the year
under audit. The adequacy of internal control over plant acquisitions and
disposals would be an important part of this review. Since Kris is a relatively
new company, this study of prior years’ transactions can be completed within
reasonable time limits.
The review of prior years’ transactions relating to plant and equipment would
include analysis of the Repairs and Maintenance expense account and should
bring to light the erroneous treatment of plant acquisitions as revenue
expenditures during Years 1 and 2.
If Ian and Ronna did not investigate the property transactions of the two prior
years and the internal controls in force, there would be no satisfactory support
for the balances of the property accounts at the end of Year 3, or for the
depreciation expense of the year under audit. Remember that one of the
auditors’ basic objectives for plant and equipment is to determine that the
property accounts (including the amounts carried forward from prior years)

are fairly stated.
(b) Both the income statement and the balance sheet prepared at the end of Year 3
would be affected by the errors made in Years 1 and 2. In the balance sheet,
the plant and equipment and also the total assets would be understated by the
undepreciated cost of the assets which were improperly expensed. Current
liabilities and total liabilities would be understated by the additional income
taxes applicable to the understatement of prior periods’ net income due to the
accounting errors. The retained earnings and total shareholders’ equity would
be understated by the difference between the understatement of total assets
and the understatement of total liabilities. In the Kris income statement,
depreciation expense would be understated, income taxes expense overstated,
and net income overstated.


Substantive Tests of Property, Plant and Equipment
11-7.

11-3

Sparrow Company
1.

Change in depreciation method is considered change in accounting estimate
--cumulative effect adjustment:
a.

No correcting entry

b.

Depreciation Expense
Accumulated Depreciation: Machine
To record depreciation for 2006.

Previous depreciation amount
2004 P400,000 x (2 x 10%)
2005 (P400,000 - P80,000) x (2 x 10%) =
Cost
Less:

Accumulated depreciation
Carrying value 12.31.05
256,000 – 50,000
Depreciation in 2006 =
8
2.

25,750
25,750

P 80,000
64,000
P144,000
P400,000
144,000
P256,000
= P25,750

Change in estimate--prospective adjustment:
a.

No correcting entry

b.

Depreciation Expense
Accumulated Depreciation: Machine
To record depreciation for 2006.
Depreciation base
Original life = Annual depreciation =

40,000
40,000
P450,000
= 9 years
P50,000

Remaining life =

(9-5) years + 1 year = 5 years
P250,000 – P50,000
Book value – Residual value
=
= P40,000 per year
Depreciation =
5
Remaining life
3.

Error--prior period adjustment:

a.

Retained Earnings
Accumulated Depreciation: Machine
Prior period adjustment for error
(P80,000 - P72,000).

8,000
8,000

Previous depreciation - erroneously calculated (P200,000 – P20,000) x
(2 x 20%) = P72,000
Correct depreciation (P200,000) x (2 x 20%) = P80,000
b.

Depreciation Expense
Accumulated Depreciation: Machine
To record depreciation for 2006.

48,000
48,000

2006 correct depreciation (P200,000 – P80,000) x (2 x 20%) = P48,000


11-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition

11-8.

Jamboree Trucking Company
Requirement (1)
Accumulated depreciation on the trucks, January 1, 2003

Truck
1
2
3
4

Cost
P120,000
104,000
128,000
150,000

Life
5
5
5
5

Annual
Depreciatio
n
P24,000
20,800
25,600
30,000

Years
Owned
3
2½
1
½

Accumulate
d
Depreciatio
n
P 72,000
52,000
25,600
15,000
P164,600

Note: This schedule is used to help determine the accumulated depreciation
to date for each correcting entry. Also see correct depreciation
schedule later in solution.
July 1, 2003
Correct entry:
Cash
Accumulated Depreciation: Trucks
[P72,000 + (P24,000 x ½)]
Loss
Trucks

10,000

84,000
26,000
120,000

Entry made:
Cash
Trucks

10,000
10,000

Correcting entry #1:
Accumulated Depreciation: Trucks
Retained Earnings
Trucks

84,000
26,000
110,000

January 1, 2004
Correct entry:
Accumulated Depreciation:
Trucks (P25,600 + P25,600)
Trucks (new)
Cash

51,200
120,000
17,800

Substantive Tests of Property, Plant and Equipment
Trucks (old)
Gain on exchange
Entry made:

11-5

128,000
25,400

Trucks
Cash

17,800
17,800

Correcting entry #2:
Trucks (new)
Accumulated Depreciation: Trucks
Trucks (old)
Retained earnings

102,200
51,200
128,000
25,400

July 1, 2005

Correct entry:
Accumulated Depreciation: Trucks
(P15,000 + P30,000 + P30,000 + P15,000)
Cash
RE on disposition of trucks
Trucks

90,000
10,000
50,000
150,000

Entry made:
Cash
Miscellaneous Revenue
Trucks

10,000
500
9,500

Correcting entry #3:
Accumulated Depreciation: Trucks
Retained Earnings
Trucks

90,000
50,500
140,500

Correct depreciation:
Truck
1
2
3
4
5
6
Total
Depreciation

2003
P12,000
P20,800
P25,600
P30,000
–
–
P88,400

2004
–
P20,800
–
P30,000
P18,920
–
P69,720

2005

–
P10,400
–
P15,000
P18,920
P12,000
P56,320

2006
–
–
–
–
P18,920
P24,000
P42,920

(88,400)

(54,360)

(41,460)

(28,560)

(P94,600  5 = P18,920)
(P120,000  5 = P24,000)


11-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Under (over)
statement

–

P15,360

P14,860

P14,360

Effect of errors on earnings (all reductions)
2003
2004
2005
2006

P26,000
P15,360
P50,500 + P14,860 = P65,360
P14,360

Correcting entry #4:
Retained Earnings
Depreciation Expense
Accumulated Depreciation

30,220
14,360
44,580

Requirement (2)
Compound AJE:
Accumulated Depreciation: Trucks (P84,000 +
P51,200 + P90,000 – P44,580)
Retained Earnings (P26,000 – P25,400 + P50,500
+ P30,220)
Depreciation Expense
Trucks (P110,000 + P102,200 – P128,000
– P140,500)
11-9.

180,620
81,320
14,360
276,300

AFH Company
Note: This question requires knowledge that corrections of errors in prior years
are recorded to Retained Earnings.
Adjusting entries at December 31, 2007, to correct the books. The building and
machinery should be recorded in separate accounts. Ignore effect on income
taxes.
Purchase price of P60,000 is a lump-sum purchase.
Building
Machinery
Machinery is valued at 40% x P60,000

Building is valued at 60% x P60,000

P39,000
26,000
P65,000
=
=

P24,000
P36,000

60%
40%
100%


Substantive Tests of Property, Plant and Equipment

AJE (1)

(2)

(3)

(4)

(5)

(6)

Machinery
Building
Property, Plant, and Equipment

24,000
36,000
60,000

Machinery
Building
Property, Plant, and Equipment
The legal fees are allocated in the
same proportion as the original
purchase.

280
420

Retained Earnings
Property, Plant, and Equipment
To correct the insurance paid in
2005 that was incorrectly recorded
in the asset account.

2,400

Property, Plant, and Equipment
Accumulated Depreciation: Building
Accumulated Depreciation: Machinery
Retained Earnings

To remove the depreciation of
P6,310 incorrectly credited to
Property, Plant, and Equipment in
2005; to credit the correct
depreciation
to
Accumulated
Depreciation: Building (P36,420 
20);
to
credit
the
correct
depreciation
to
Accumulated
Depreciation: Machinery (P24,280
 8); and to correct the amount
recorded as depreciation expense by
a credit to Retained Earnings.

6,310

Retained Earnings
Property, Plant, and Equipment
To correct the 2006 repairs that were
incorrectly recorded in the asset
account.

2,000

Building
Property, Plant, and Equipment

11-7

700

2,400

1,821
3,035
1,454

2,000

10,000
10,000


11-8

Solutions Manual to Accompany Applied Auditing, 2006 Edition
To properly classify the
addition to the building.
(7)

(8)

(9)

(10)

(11)

2006

Property, Plant, and Equipment
Accumulated Depreciation: Building
Accumulated Depreciation: Machinery
Retained Earnings
To remove the depreciation of
P6,879 incorrectly credited to
Property, Plant, and Equipment in
2006; to credit the correct
depreciation
to
Accumulated
Depreciation: Building [P1,821 +
(P10,000  19)] (this assumes the
addition has the same life as the
building); to credit the correct
depreciation
to
Accumulated
Depreciation: Machinery (P24,280
 8); and to correct the amount
recorded as depreciation expense by
a credit to Retained Earnings.

6,879

Repairs Expense
Property, Plant, and Equipment
To expense the repairs for 2007,
before the books are closed.

3,000

Insurance Expense
Prepaid Insurance
Property, Plant, and Equipment
To correctly classify the 2007
insurance payment, before the books
are closed.

1,400
1,400

Machinery
Property, Plant, and Equipment
To correctly classify the machinery
purchased in 2007.

7,000

Loss on Disposal of Machinery
Property, Plant, and Equipment
Accumulated Depreciation: Machinery
Machinery

To correctly record the disposal of

100
500
200

2,347
3,035
1,497

3,000

2,800

7,000

800


Substantive Tests of Property, Plant and Equipment

11-9

the machinery in 2007; the machine
is 2 years old and so has P200
related accumulated depreciation.
(12)

11-10.

Property, Plant, and Equipment
Accumulated Depreciation: Building
Accumulated Depreciation: Machinery
Depreciation Expense
To remove the depreciation of
P7,421 incorrectly credited to
Property, Plant, and Equipment in
2004; to credit the correct
depreciation
to
Accumulated
Depreciation: Building; to credit the
correct depreciation to Accumulated
Depreciation: Machinery [(P24,280
+ P7,000 - P800)  8]; and to correct
the depreciation expense before the
books are closed.

7,421
2,347
3,810
1,264

Briggs, Inc.
Adjusting Journal Entries - 12/31/06
(1)

(2)

(3)

(4)

(5)

(6)

Organization costs
Fixed assets

3,000

Discount on bonds payable
Interest expense
Fixed assets

5,650
350

Land
Fixed assets

3,000

6,000
500,000
500,000

Organization costs
Fixed assets

5,000

Land
Fixed assets

4,000

Land
Fixed assets

7,000

5,000

4,000

7,000


11-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition
(7)

(8)

(9)

(10)

(11)

11-11.

Interest expense
Fixed assets

30,000

Salaries expense
Fixed assets

50,000

Organization costs
Fixed assets

40,000

Taxes and licenses
Fixed assets

7,000

Building
Fixed assets

30,000

50,000

40,000

7,000
2,000,000
2,000,000

Aerospace Company
Requirement (1)
Machinery (cost)
Raw materials used
Labor
Installation cost
Materials used in trial runs
Factory overhead (incremental)
Total
Less: Cash discount on materials
Net

P13,600
9,800
1,400
600
2,900
P28,300
400
P27,900

Accumulated depreciation - 12/31/06

(P27,900 x 10% x 4/12)

P

Machine Tools (cost)
Less: Amortization for 2006 (4/36 x 2,250)
Balance, 12/31/06

P 2,250
250
P 2,000

930

Requirement (2) Adjusting Journal Entries - 12/31/06
(1)
(2)

Loss on disposition of machinery
Machinery
Profit on construction

70
70
6,900


Substantive Tests of Property, Plant and Equipment
Machinery
(3)

(4)

(5)
(6)

11-12.

2,250

Machinery
Depreciation expense
Accumulated depreciation - machinery

3,462

Machinery
Factory overhead control

(7)

6,900

Machine tools
Machinery

Purchase discount
Machinery

Tools expense
Machine tools

11-11

2,250
2,532
930
400
400
2,900
2,900
250
250

XYZ Manufacturing Company
Adjusting Journal Entries - 12/31/06
AJE (1)

(2)

(3)

Retained Earnings
Machinery
To correct error in recording
purchase
of
machine
on
installment basis.
List Price

P6,000
Add: Installation charges
200
Total
P6,200
Total installments paid
& installation
7,400
Financing charges
P1,200

1,200.00

Retained Earnings
Machinery
To take up cash discount on
machinery purchased on 6/30/03.

160.00

Machinery (new)
Allowance for depreciation
Machinery (old)

1,200.00

160.00

2,620.00
2,620.00

5,240.00


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Solutions Manual to Accompany Applied Auditing, 2006 Edition
To write off machinery traded in
for a new one.
Cost of new machine:
Cash payment
P5,000
NBV of old machine
2,620
Total
P7,620

(4)

(5)

(6)

(7)

Allowance for depreciation
Machinery
Retained earnings
To correct the recording of sale of
machinery on 1/1/05.
Cost

P4,400
Less: Acc. Depr.
2,640
NBV
1,760
Proceeds (2,500 - 125)
2,375
Gain
P 615

2,640.00

Allowance for depreciation
Machinery
Gain on sale of machinery
To correct the recording of sale of
machinery on 10/1/06.
Cost
P4,000
Less: Acc. Depr.
3,800
NBV
200
Proceeds
800
Gain
P 600

3,800.00

Machinery
Allowance for depreciation
To set up client’s depreciation
provisions from 2002 to 2006
erroneously credited to the
Machinery acct. (Schedule A).

19,900.60

Depreciation expense
Retained earnings
Allowance for depreciation
To correct error in depreciation
provisions of client (Schedule B).

2,190.90
1,536.50

XYZ Manufacturing Corporation

2,025.00
615.00

3,200.00
600.00

19,900.60

3,727.40

Substantive Tests of Property, Plant and Equipment

11-13

Machinery
12/31/06
Balance per ledger (Schedule A)
Add (Deduct) Adjustments
AJE (1)
(2)
(3)
(4)
(5)
(6)

P10,964.40

Net

P10,695.60

( 1,200.00)
( 160.00)
2,620.00
( 5,240.00)
( 2,025.00)
( 3,200.00)
19,900.60

Balance as adjusted

P21,660.00

Composition:
Machine acquired on 9/30/02
Machine acquired on 6/30/03
Machine acquired on 6/30/04
Total

P 6,200.00
7,840.00
7,620.00
P21,660.00

XYZ Manufacturing Corporation
Allowance for Depreciation
12/31/06
Balance per ledger
Add (Deduct) Adjustments
AJE (3)
(4)
(5)
(6)
(7)
Balance as adjusted

( 2,620.00)
( 2,640.00)
( 3,800.00)

19,900.60
3,727.40
P14,568.00

Composition:
A D - Machine acquired on 9/30/02
- Machine acquired on 6/30/03
- Machine acquired on 6/30/04
Total

P 5,270.00
5,488.00
3,810.00
P14,568.00

Supporting Analysis:
Schedule A

Machinery Account per Ledger

P

0.00


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Solutions Manual to Accompany Applied Auditing, 2006 Edition

Date

Particulars

1/1/02

Purchase

9/30/02

Purchase on installment
Payments from Sept. to Dec.
Freight and installation
Depreciation (20%)

10/10/02
12/31/02
2003

Schedule B
Date
Acquired

9/30/02
6/30/03
6/30/04

Balance

P13,640.00

2,400.00
200.00
P 3,248.00
4,800.00
8,000.00

16,040.00
16,240.00
12,992.00

5,126.72
2,375.00
3,626.38
800.00
2,741.10

17,792.00
25,792.00
20,633.60
25,633.60
20,506.88
18,131.88
14,505.50
13,705.50
10,964.40

2005

2006

5,158.40
5,000.00

Depreciation Schedule
Cost

2002

2003

2004

P 5,240
4,000
4,400
6,200
7,840
7,620

P 1,048.00
800.00
880.00
310.00
0.00
0.00

P1,048.00
800.00
880.00
1,240.00

784.00
0.00

P 524.00
800.00
880.00
1,240.00
1,568.00
762.00

Total correct
depreciation provision
Provision by client
(Over) Underprovision
11-13.

Cr

P 5,240.00
4,000.00
4,400.00

Installment payments for acquisition
on 9/30/02
Purchase
Depreciation (20%)
Acquisition - old machine traded in
Depreciation (20%)
Sale
Depreciation (20%)

Sale
Depreciation (20%)

6/30/03
12/31/03
6/30/04
12/31/04
1/1/05
12/31/05
10/1/06
12/30/06

1/1/02

Dr

P 3,038.00 P4,752.00 P 5,774.00
3,248.00
5,158.40
5,126.72
P (210.00) P (406.40) P 647.28

P

0.00
800.00
0.00
1,240.00
1,568.00
1,524.00

P

P5,132.00
3,626,38
P1,505.62

P4,932.00
2,741.10
P2,190.90

Sunlight Service Center
Audit Adjustment No. 1 was determined as follows:
Client’s Entry
(1) To record disposal of delivery truck:

Correct Entry

0.00
600.00
0.00
1,240.00
1,568.00
1,524.00


Substantive Tests of Property, Plant and Equipment
Cash
Trucks

2,000
2,000

11-15

Cash
2,000
Accum. Depr.
50,000
Trucks
50,000
Gain/Loss on Disp.
2,000

(2) To record disposal of service truck:
Cash
Trucks

8,000
8,000

Cash
Accum. Depr.
Gain/Loss on Disp.
Trucks

8,000
15,000
2,000
25,000

(3) To record 2006 depreciation:
Depr. Expense
Accum. Depr.

95,000
95,000

Depr. Expense
Accum. Depr.

101,250
101,250

Correct amount of depreciation determined as follows:
Disposal of service truck (1/2 year)
Purchase of delivery truck (1/2 year)
Purchase of service truck (1/2 year)
Two delivery truck @ 10,000 each
Fourteen service trucks @ 5,000 each
Total

P 2,500
6,000
2,750
20,000
70,000
P101,250

Audit Adjustment as shown below:

Accumulated Depreciation - Trucks
Depreciation Expense - Trucks
Trucks
b.

58,750
6,250
65,000

The audit objectives for examining the asset and related accumulated
depreciation accounts are:
(1)

Existence or occurrence: To establish the physical presence of the assets
and the validity of the purchase and sale transactions.

(2)

Rights and obligations: To ascertain that Sunlight owns the trucks.

(3)

Valuation or allocation: To determine that the company has properly
recorded the acquisitions and disposals, and that depreciation has been
properly calculated for 2006.

(4)

Presentation and disclosure: To resolve that all trucks are used in the
company’s operations; that fully-depreciated trucks are removed from the

books if no longer in use; that trucks and accumulated depreciation are
reflected as operating assets; and that depreciation expense is reflected as
an operating expense.


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Solutions Manual to Accompany Applied Auditing, 2006 Edition
Auditing procedures appropriate in meeting the above objectives are the
following:
(1) Existence or occurrence, valuation or allocation, and ownership: Trace to
last year’s audit workpapers and examine titles for trucks purchased prior to
2006 (to determine that trucks are still owned by the client; examine titles and
invoices for trucks purchased in 2006; examine remittance advices, journal
entries and bank statement credits for 2006 disposals; and recompute
depreciation expense and gain/loss on disposals.
(2) Presentation and disclosure: Examine subsidiary ledger for fully depreciated
assets and inquire as to whether in use. Reclassify as necessary.


11-18
11-13.

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Sunlight Service Center (CONTINUED. . . . Requirements a and c)

SUNLIGHT SERVICE CENTER
TRUCKS
December 31, 2006

Description
Assets:
Delivery Trucks
Service Trucks

Final
Balances
12/31/01

Additions

P150,000
P375,000
P525,000 &
F

P 60,000 
P 27,500 
P 87,500
F

Disposals
P51,000
P25,000
P76,000
F

12/31/06: Ledger balance
AJE No. 1

12/31/06: Audited balances

Accumulated Depreciation:
Delivery Trucks
Service Trucks

P 95,000
P225,000
P320,000 &
F

12/31/06: Ledger balances
AJE No. 1

P 26,000 (B)
P 75,250 (C)
P101,250
F
P 95,000
P 6,250
P101,250

P 50,000
15,000 (A)
P 65,000
F

Final
Balances
12/31/02

P160,000
P377,500
P537,500
F
P602,500
P 65,000
P537,500
WP G

P 71,000
P285,250
P356,250
F
P415,000
P 58,750
P356,250

Evaluated depreciation policy and estimated lives for reasonableness. No exception:
AJE No. 1
Depreciation expense - trucks
P 6,250
Accum. depreciation - trucks
58,750
Trucks
P65,000
&
*

Traced to last year’s working trial balance
Traced to remittance advice and cash receipts

F


Footed and crossfooted
Examined invoices and titles

Gain (loss)
on Disposals
P 2,000
(P2,000)
P
0

*
(A)

(A)
Cost
Accum. Depr:
2003
2,500
2004
5,000
2005
5,000
2006
2,500

(1/2 yr.)

Book Value
Sales Price
Loss

P10,000
8,000
P 2,000

*

20,000
6,000
P 26,000

(1/2 yr.)

70,000
2,500
2,750
P 75,250

(1/2 yr.)
(1/2 yr.)

(B)
2 x 10,000
1 x 6,000

WP G

14 x 5,000
1 x 2,500
1 x 2,750

P25,000

(1/2 yr.)
15,000


Substantive Tests of Property, Plant and Equipment
11-14.

11-19

Tatty Company’s
Requirement (1)
Tatty Company
Analysis of Land Account
for 2007
Balance at January 1, 2007
Land site number 621:
Acquisition cost
Commission to real estate agent
Clearing costs
Less: Amounts recovered
Total land site number 621
Land site number 622:
Acquisition cost
Demolition cost of building

Total land site number 622
Balance at December 31, 2007

P 100,000
P1,000,000
60,000
P15,000
(5,000)

10,000
1,070,000
P 300,000
30,000
330,000
P1,500,000

Tatty Company
Analysis of Buildings Account
for 2007
Balance at January 1, 2007
Cost of new building constructed on
land site number 622:
Construction costs
Excavation fees
Architectural design fees
Building permit fee
Balance at December 31, 2007

P800,000
P150,000

11,000
8,000
1,000

170,000
P970,000

Tatty Company
Analysis of Leasehold Improvements Account
for 2007
Balance at January 1, 2007
Electrical work
Construction of extension to current
work area (P80,000 x ½)
Office space
Balance at December 31, 2007

P500,000
35,000
40,000
65,000
P640,000


11-20

Solutions Manual to Accompany Applied Auditing, 2006 Edition
Tatty Company
Analysis of Machinery and Equipment Account
for 2007

Balance at January 1, 2007
Cost of new machines acquired:
Invoice price
Freight costs
Unloading charges
Balance at December 31, 2007

P700,000
P75,000
2,000
1,500

78,500
P778,500

Requirement (2)
Items in the fact situation which were not used to determine the answer to
Requirement 1 above, and where, or if, these items should be included in Tatty’s
financial statements are as follows:

11-15.

a.

Land site number 623, which was acquired for P600,000, should be included
in Tatty’s balance sheet as land held for resale.

b.

Painting of ceilings for P10,000 should be included as a normal operating

expense in Tatty’s income statement.

c.

Royalty payments of P13,000 should be included as a normal operating
expense in Tatty’s income statement.

Nikko Company
Note to Instructor: This problem includes material from previous chapters.
JOURNAL ENTRIES DURING 2006:
(1)

Land
Ordinary Shares, P10 par
Additional Paid-in Capital
a

175,000 a
70,000
105,000

P25 x 7,000

Cash
Notes Payable

500,000

Building
Cash

700,000

500,000

700,000


Substantive Tests of Property, Plant and Equipment
(2)

(3)

(4)

Machine
Accumulated Depreciation
Machine
Cash
Gain on exchange

430,000
135,000

Cash
Sales Revenue

800,000

Cost of Goods Sold

Inventory

350,000

Accounts Payable
Cash

400,000

Inventory
Accounts Payable

480,000

Dividends Distributed (or Retained Earnings)
Cash
a

11-21

500,000
60,000
5,000
800,000
350,000
400,000
480,000
92,500
92,500 a

37,000 x P2.50

ADJUSTMENTS AT END OF 2006:
Interest Expense
Building
Interest Payable
a
b

60,000 a

P500,000 x 12%
[(P0 + P700,000)  2] x 12%

Depreciation Expense - Machinery
Accumulated Depreciation
a

18,000
42,000 b

75,000 a
75,000 a

(P430,000 – P55,000)  5

Rent Expense
Prepaid Rent

60,000

Income Tax Expense
Income Taxes Payable

90,600 a

a

See income statement

60,000
90,600


11-22

Solutions Manual to Accompany Applied Auditing, 2006 Edition
FINANCIAL STATEMENTS FOR 2006:
NIKKO COMPANY
Income Statement
For Year Ended December 31, 2006
Sales revenue
Less: Expenses
Cost of goods sold
Interest expense
Depreciation expense
Rent expense
Operating income
Gain on exchange of machinery
Income before income taxes

Income tax expense (30%)
Net income

P800,000
P350,000
18,000
75,000
60,000

Earnings per share (37,000 shares)

(503,000)
P297,000
5,000
P302,000
90,600
P211,400
P

5.71

NIKKO COMPANY
Statement of Retained Earnings
For Year Ended December 31, 2006
Beginning retained earnings
Add:
Net income

P200,000
211,400

P411,400
(92,500)
P318,900

Less: Dividends
Ending retained earnings
NIKKO COMPANY
Balance Sheet
December 31, 2006
Assets
Cash
Inventory
Land
Building
Machine
Less: Accumulated depreciation
Total Assets

P 587,500
580,000
175,000
742,000
P430,000
(75,000)

355,000
P2,439,500

a
b

Substantive Tests of Property, Plant and Equipment

11-23

Liabilities and Equities

11-16.

Accounts payable
Notes payable
Interest payable
Income taxes payable
Total Liabilities

P 480,000
500,000
60,000
90,600
P1,130,600

c

Ordinary shares, P10 par
Additional paid-in capital
Retained earnings
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity

P 370,000
620,000
318,900
P1,308,900
P2,439,500

d
e

a

P540,000 + P500,000 – P700,000 – P60,000 + P800,000 – P400,000 – P92,500
= P587,500

b

P450,000 – P350,000 + P480,000 = P580,000

c

P400,000 – P400,000 + P480,000 = P480,000

d

P300,000 + P70,000 = P370,000

e

P515,000 + P105,000 = P620,000

Apple Company
Requirement 1
Total expenses, 2005 = Units sold x (Depletion + Depreciation
+ Production costs)
= (6 x 9,000) x (P3.00a + P0.20b + P8.00)
= 54,000 x P11.20
= P604,800

a

Cost – Residual Value
Depletion rate Life
= in tons
P2,000,000  (P100,000 – P200,000)
=
700,000
P2,100,000
=
700,000


11-24

Solutions Manual to Accompany Applied Auditing, 2006 Edition
= P3.00 per ton

b

Cost – Residual Value
Depreciation rate =Life in tons

P150,000 – P10,000
=700,000
=

P0.20 per ton

Requirement 2
Cost of inventory, 12/31/2005

=

6 x (10,000 – 9,000) x P11.20

=

P67,200

Requirement 3
Total expenses, 2006 = Units sold x (Depletion + Depreciation
+ Production costs)
= (6 x P11.20) + [(12 x 10,000) – 6,000] x
(P3.84a + P0.256b + P8.00)
= P67,200 x P1,378,944
= P1,446,144
a

Book value – Residual Value
New depletion rate =Remaining Life
[P2,000,000  (60,000 x P3.00)] – (P100,000 – P200,000)]
=

500,000
P1,820,000 + P100,000
= 500,000
P1,920,000
=
500,000
= P3.84 per ton

b

Book value – Residual Value
New depreciation rate =Remaining Life
[P150,000  (60,000 x P0.20)] – P10,000
=
500,000


Substantive Tests of Property, Plant and Equipment

11-25

P128,000
=
500,000
=

P0.256 per ton

11-17.
January 1, 2001

Equipment
Cash

5,000,000
5,000,000

December 31, 2001
Depreciation Expense
Accumulated Depreciation

500,000
500,000

December 31, 2002
Depreciation Expense
Accumulated Depreciation

500,000
500,000

January 1, 2003
Equipment
Accumulated Depreciation
Revaluation Surplus

625,000
125,000
500,000

December 31, 2003

Depreciation Expense
Accumulated Depreciation
Revaluation Surplus
Retained Earnings

562,500
562,500
62,500
62,500

December 31, 2004
Depreciation Expense
Accumulated Depreciation
Revaluation Surplus
Retained Earnings

562,500
562,500
62,500
62,500

December 31, 2005
Depreciation Expense
Accumulated Depreciation
Revaluation Surplus
Retained Earnings

562,500
562,500
62,500

62,500


11-26

Solutions Manual to Accompany Applied Auditing, 2006 Edition
January 1, 2006
1) Revaluation surplus
Accumulated depreciation
Equipment

312,500
312,500

2) Impairment loss / Depreciation expense
Accumulated depreciation

500,000

625,000
500,000

or
Revaluation surplus
Impairment loss / Depreciation expense
Accumulated depreciation
Equipment
11-18.

312,500

500,000
187,500
625,000

Sweetie Company
Requirement (a)
December 31, 2006
Loss on Impairment / Depreciation....................................................................................
3,200,00
0
Accumulated Depreciation—Equipment..............................................................
3,200,00
0
Cost
Accumulated depreciation
Carrying amount
Fair value
Loss in impairment

P9,000,000
1,000,000
8,000,000
4,800,000
P3,200,000

Requirement (b)
December 31, 2007
Depreciation Expense........................................................................................................
1,200,000
Accumulated Depreciation—Equipment..............................................................

1,200,000
New carrying amount
Useful life
Depreciation per year

P4,800,000
4 years
P1,200,000

Requirement (c)
Carrying value, 12.31.07 had impairment not been recognized on 12.31.06
Cost

P9,000,000