Solution with answer applied auditing by cabrera chapter08

CHAPTER 8-1 SUBSTANTIVE TESTS OF RECEIVABLES AND SALES Tests of details of financial balances are designed to determine the reasonableness of the balances in sales, accounts receivable, and other account balances which are affected by the sales and collection cycle Such tests include confirmation of accounts receivable, and examining documents supporting the balance in these accounts Tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal control structure and to test the substance of the transactions which are produced by this cycle Such tests would consist of examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval of credit The results of the tests of transactions will be used to affect the procedures, sample size, timing and particular items selected for the tests of details of financial balances (i.e., an effective internal control structure will result in reduced testing when compared to the tests of details required in the case of an inadequate internal control structure) 8-2 There are two common types of confirmations used for confirming accounts receivable: “positive” confirmations and “negative” confirmations A positive confirmation is a communication addressed to the debtor requesting him to confirm directly whether the balance as stated on the confirmation request is correct or incorrect A negative confirmation is also a communication addressed to the debtor, but it requests a response only when the debtor disagrees with the stated amount A positive confirmation is more reliable evidence because the auditor can perform follow-up procedures if a response is not received from the debtor With a negative confirmation, failure to reply must be regarded as a correct response even though the debtor may have ignored the confirmation request Offsetting the reliability disadvantage, negative confirmations are less expensive to send than positive confirmations, and thus more of them can be distributed for the same total cost The determination of which type of confirmation to be sent is an auditor’s decision, and it should be based on the facts in the audit The following are the most important circumstances where positive confirmations should be used: 8-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition There are a small number of large accounts which account for a significant portion of total accounts receivable There are suspected conditions of dispute, inaccuracy, or irregularity This would be the case when internal controls are considered inadequate or if prior year’s audit test results are unsatisfactory The rules of certain regulatory agencies require them This is the case for brokers and dealers in securities When the above conditions not exist, it is acceptable to use negative confirmations, but negative confirmations should not be used if the auditor believes the customer is likely to ignore the confirmation Typically, when negative confirmations are used, the auditor is using a reduced control risk assessment in the audit of accounts receivable It is also common to use negative confirmations for audits of hospitals, retail stores, and other industries where the receivables are due from the general public In these cases, far more assurance is obtained from tests of internal control than from confirmations It is also common to use a combination of negative and positive confirmations by sending the positives to accounts with large balances and negatives to those with small balances 8-3 It is acceptable to confirm accounts receivable prior to the balance sheet date if the internal control structure is adequate and can provide reasonable assurance that sales, cash receipts and other credits are properly recorded between the date of the confirmation and the end of the accounting period Other factors the auditor is likely to consider in making the decision are the materiality of accounts receivable and the auditor’s experience in prior years If the decision is made to confirm accounts receivable prior to year end, it is necessary to test the transactions occurring between the confirmation date and the balance sheet date by examining internal documents and performing analytical procedures at year end 8-4 South Technologies, Inc (a) When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the auditors’ purpose is to determine that the receivables were genuine when they were first recorded in the accounts In some fraud cases, fictitious accounts receivable have been created to cover up a shortage Eventually these fictitious receivables must be disposed of; one method is to write off the fictitious accounts as uncollectible (b) The South executive appears to believe the auditors are solely concerned with the collectibility of accounts and notes receivable In fact, the confirmation process is primarily intended to establish that the receivables are genuine and that the customers (or makers of notes) exist Other audit procedures are followed to determine collectibility Substantive Tests of Receivables and Sales 8-3 8-5 The confirmation requests should go to the makers of the notes regardless of whether the notes have been discounted The act of discounting a note receivable does not reduce the importance of the note being genuine and collectible A company which discounts its notes receivable remains in a position of sustaining a loss if the makers of the notes fail to make payment at the maturity dates 8-6 (a) When customers fail to respond to positive confirmation requests the CPAs may not assume with confidence that these customers reviewed the requests and found no disagreement and therefore did not reply Some busy customers will not take the time to review confirmation requests and will not respond; hence, obvious exceptions may exist without being reported to the CPAs (b) If there is no response to a second request, the CPAs may mail a third request and possibly make telephone calls in an effort to get a reply directly from the customer When it becomes apparent that the confirmation program will not produce further evidence, the CPAs should consider each remaining customer as to the size, nature, and age of the balance and the apparent reason for the lack of a reply before they decide what additional work is necessary in the circumstances The CPAs should carry out the alternative audit procedures of examining customers’ purchase orders or contracts, shipping documents and sales invoices of the client, and remittances by nonconfirming customers received by the client subsequent to the balance sheet date The auditors may also verify the existence, location, and credit standings of the nonconfirming customers by reference to credit agencies or other sources independent of the client 8-7 North, Inc No, the matter remains unresolved First, oral evidence from the client is never in itself sufficient; the auditors must follow up to determine the reliability of the oral evidence Second, payment of an account receivable is not confirmation; the account might be fictitious, and the “payment” could have been made by a dishonest employee who had created the fictitious account to conceal a cash shortage The auditors must examine the customer purchase order or contract, and copies of the sales invoice and shipping document, in support of the unconfirmed receivable They should also determine the genuineness of the customer by reference to the telephone directory or to credit agency reports 8-8 Monty’s Meat, Inc a The workpaper does not include a description of the auditing procedures performed in confirming the accounts The workpaper is also incomplete in the following respects: 1) The workpaper does not state whether the auditor traced the ABC Grocery remittance of P3,000 to November cash receipts 8-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition 2) The workpaper does not state whether the auditor examined the November credit memo issued to Sari-Sari Store 3) The workpaper does not state whether the auditor traced the Lucena’s Meat Market remittance to November cash receipts 4) The workpaper does not state whether and how the auditor obtained satisfaction regarding confirmation requests not returned 5) The workpaper does not state whether the auditor examined documentation for the Diana’s Supper Club order returned and received on October 31 6) Rather than summarizing the confirmations returned without exception, as was done at the bottom of Working Paper 1, these confirmations should have been listed separately b 1) Sales Accounts receivable P11,100 P11,100 Inventory Cost of goods sold 8,600 8,600 To reverse 2007 sale recorded in 2006 2) Allowance for uncollectible accounts Accounts receivable 1,277 1,277 To write off uncollectible account 3) Sales returns and allowances Accounts receivable 3,634 3,634 To record return of spoiled meat and recognize loss in period in which incurred Meat not restored to inventory, inasmuch as it was spoiled 4) Sales Accounts receivable 13,000 13,000 To correct error in recording customer remittance as a sale 5) Sales Returns Accounts receivable Inventory Cost of goods sold To record return and restore meat to inventory because meat returned in good condition 334 334 250 250 Substantive Tests of Receivables and Sales c 8-5 (See completed Exhibits 1.1 and 1.2 reproduced below and on the following page.) Exhibit 1.1 Monty’s Meat, Inc Accounts Receivable - Trade Aging Analysis October 31, 2006 Conf No 1060 1061 1064 1602 1603 1607 1608 1612 10/31 10/31 11/27 Customer Balance Culley’s Meats Jolly Roger Restaurant ABC Grocery (Other) Rudy’s Deli General Foods Grocers Kim’s Fresh Meats Dill’s Discount Grocery Diana’s Supper Club Balance per ledger Audit Adjustments P 1,330 466 4,256 329,433 378 13,468 2,334 12,469 866 P365,000 P (29,345) Audited balance P335,655 # Current P & # Past Due (Days) 31-60 Over 60 1,330 P 3,000 280,763 13,000 1,074 12,469 334 P 311,970 P (28,068) 466 1,256 33,467 P12,324 P 2,879 378 468 1,260 P 36,449 532 P13,234 P 3,347 P(1,277) P 283,902 P 36,449 P13,234 P 2,070 Cash receipts 11/1 – 11/27 P(210,113) P (13,353) P Outstanding P 73,789 P 23,096 P13,234 P 2,070 10% 25% 7,379 P 5,774 Estimated percent uncollectible 10/31 1-30 Estimated uncollectible P 24,487 P P 70% Reviewed by: Initial Date 100% P 9,264 P 2,070 Traced subsequent collections to November remittance advices Obtained balances from subsidiary ledger after agreeing to general ledger control account Prepared by: Initial Date & 8-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition Exhibit 1.2 Monty’s Meat, Inc Accounts Receivable - Trade Allowance for Doubtful Accounts October 31, 2006 11/1/05 11/1 - 10/31 11/1 - 10/31 Balance per general ledger Monthly provision Write-offs P28,000 # 24,000 & (37,000) @ 10/31/06 Balance per general ledger P15,000 AJE AJE (1,277) P13,723 P10,777 Audited balance P24,500 10/31/06 AJE Bad debts expense Allowance for doubtful accounts P10,777 P10,777 To adjust allowance for doubtful accounts to amount considered reasonable in the circumstances # & @ ^ Traced to last year’s WTB - audited balance Traced to standard journal entries Examined documentation and discussed with credit manager and legal counsel In light of aging analysis, the above balance, as adjusted, appears to be adequate Prepared by: Initial Date Reviewed by: Initial Date ^ Substantive Tests of Receivables and Sales 8-9 8-7 Makati Company For all of the exceptions, the auditor is concerned about four principal things (a) Whether there is a client error Many times the confirmation response differences are due to timing differences for deposits in the mail and inventory in transit to the customer Sometimes customers misunderstand the confirmation or the information requested The auditor must distinguish between those and client errors (b) The amount of the client error if any (c) The cause of the error It would be intentional, a misunderstanding of the proper way to record a transaction, or a breakdown of internal control (d) Potential errors in the sample not tested The auditor must estimate the error in the untested population, based on the results of the tests of the sample Suggested steps to clear each of the comments satisfactorily are: (a) Examine supporting documents, including the sales invoices and applicable sales and shipping orders, for propriety and valuation of the sales (b) Review the cash receipts books for the period after December 31, 2005, and note any collections from the PDQ Company The degree of internal control over cash receipts should be an important consideration in determining the reliance that can be placed on the cash receipts entries In addition, as there is no assurance that collections after December 31 represent the payment of invoices supporting the December 31 trial balance, consideration should be given to requesting a confirmation from the PDQ Company of the invoices paid by their checks (a) The cause should be investigated thoroughly If the credit was posted to the wrong account, it may indicate merely a clerical error On the other hand, posting to the wrong account may indicate lapping (b) Such a comment may also indicate a delay in posting and depositing of receipts If upon investigation such is the case, the company should be informed immediately so that it can take corrective steps This is a confirmation of the balance with an additional comment Since the customer has given us the data, it is preferable to check to see that the information agrees with the company’s records Such a procedure may disclose misposting or delay in recording receipts This incomplete comment should raise an immediate question: does the customer mean paid before or paid after December 31? Because the customer’s intent is unknown, this account should be reconfirmed and the customer asked to state the exact date Upon receipt of the second confirmation, the information thereon should be traced to the cash receipts book 8-8 Solutions Manual to Accompany Applied Auditing, 2006 Edition The auditor should first evaluate how long it takes to ship goods to the customer in question If it ordinarily takes more than five days, there is no indication of error A comment of this type may indicate that the company may be recording sales before an actual sale has taken place The auditor should examine the invoice and review with the appropriate officials the company’s policies Sales, cost of sales, inventories and accounts receivable may have to be adjusted if title has not passed to the buyer as of December 31, 2005 (a) Determine if such advance payment has been received and that it has been properly recorded A review should be made of other advance payments to ascertain that charges against such advances have been properly handled (b) If the advance payment was to cover these invoices, the auditor should propose a reclassification of the P1,350, debiting the advance payment account and crediting accounts receivable trade (a) Examine the shipping order for indications that the goods were shipped and, if available, carrier’s invoice and/or bill of lading for receipt of the goods (b) If it appears that goods were shipped, send all available information to the customer and ask the customer to reconfirm If the customer still insists that goods were never received, all data should be presented to an appropriate company official for a complete explanation This may indicate that accounting for shipments is inadequate and consideration should be given to reviewing the procedures to determine if improvements can be made (c) If the goods were not shipped, the auditor should recommend an adjustment reducing sales, cost of sales, and accounts receivable, and increasing inventories This should be discussed with the appropriate officials and correspondence with the customer should be reviewed to allow determination whether an adjustment should be made in the amount receivable or if an allowance for doubtful accounts should be set up As title on any goods shipped on consignment does not pass until those goods are sold, the sales entry should be reversed, inventory charged, and cost of sales credited if it is actually a consignment sale Other so-called sales should be reviewed and company officials queried to determine if other sales actual represent consignment shipments; if so, the adjustment set forth in the preceding sentence should be made for all consignment shipments 10 This is a noncurrent asset and should be reclassified to either deposit or prepaid rent A review of other accounts, especially those with round numbers, may disclose other accounts that should be so reclassified 11 This may indicate a misposting of the credit or a delay in posting the credit Comments under above would also apply to credits Substantive Tests of Receivables and Sales 8-10 8-9 Ken Company Requirement (a) Ken Company Accounts Receivable Aging Schedule May 31, 2006 Age Category Not yet due Less than 30 days past due 30 to 60 days past due 61 to 120 days past due 121 to 180 days past due Over 180 days past due Proportion of Total Amount in Category Probability of Non-Collection 680 150 080 050 025 015 1.000 P 816,000 180,000 96,000 60,000 30,000 18,000 P1,200,000 010 035 050 090 400 900 Estimated Uncollectibl e Amount P 8,160 6,300 4,800 5,400 12,000 16,200 P52,860 Requirement (b) Ken Company Analysis of Allowance for Doubtful Accounts May 31, 2006 June 1, 2005 balance Bad debt expense accrual (3,000,000 x 04) Balance before write-offs of bad accounts Write-offs of bad accounts Balance before year-end adjustment Estimated uncollectible amount Additional allowance needed P 30,250 120,000 P150,250 108,750 P 41,500 52,860 P 11,360 Debit Bad Debts Expense Allowance for Doubtful Accounts Credit 11,360 11,360 Requirement (c) Steps to Improve the Accounts Receivable Situation Establish more selective credit-granting policies, such as more restrictive credit requirements or more thorough credit rating investigation Risks and Costs Involved This policy could result in lost sales and increased costs of credit evaluation Ken may be all but forced to adhere to the prevailing credit-granting policies of the office equipment and supplies industry Establish a more rigorous collection policy either through external collection agencies or by Ken’s own personal This policy may offend current customers and thus risk future sales Increased collection costs could result from this policy 8-10 8-11 Solutions Manual to Accompany Applied Auditing, 2006 Edition Charge interest on overdue accounts This policy may offend current customers and thus risk future sales Insist on cash on delivery (COD) or cash on order (COO) for new customers or poorer credit risks This policy could result in lost sales and increased administrative costs Demo Inc Requirement (a) DEMO INC Accounts Receivable 12-31-05 Balance Per General Per Ledger Subsidiary Unadjusted Balances Add (Deduct) Adjustments: AJE (2) to correct understatement of accounts written off on October 31 P197,000 P198,240 AGING DISTRIBUTION Months Outstanding 0-1 1-3 3-6 over P93,240 P76,820 P22,180 P6,000 (200) (3) to write off definitely uncollectible accounts (1,000) (1,000) (4) to reclassify advances from customers 2,000 2,000 (5) to reclassify accounts with credit balances 500 500 1,440 _ _ _ _ P199,740 P199,740 P95,240 P77,320 P22,180 P5,000 (6) to adjust general ledger balance to agree with subsidiary balance Balances as adjusted (1,000) 2,000 500 DEMO INC Allowance for Doubtful Accounts 12-31-05 Balance per Ledger Add (Deduct) Adjustments: AJE (1) to correct error in recording bad debts recovery (2) to correct understatement of accounts written off (3) to write off definitely uncollectible accounts (4) to adjust allowance to required balance (Schedule 1) P12,000.00 324.00 ( 200.00) ( 1,000.00) ( 6,359.80) 8-13 Substantive Tests of Receivables and Sales f debts in the previous years Therefore, the bad debts on 2005 sales of P6,200 and P1,000 are about 92.2% of the total bad debts expected on 2005 sales P19,900 + P210,000 - P200 - P14,200 - P178,800 - P300 - P700 - P6,200 = P29,500 Bad debts estimated as a percentage of year-end accounts receivable P29,500 + P235,000 - P300 - P19,500 - P400 - P1,000 - P200,000 = P43,300 P43,300 x 0.285 = P12,340.50, or approximately P12,300 Criteria for recognition of bad debts or impairment of receivables under PAS 39 should be applied 8-14 Flores Corporation Requirement (1) Flores Corporation Analysis of Changes in the Allowance for Doubtful Accounts For the Year Ended December 31, 2006 Balance at January 1, 2006 Provision for doubtful accounts (P9,000,000 x 2%) Recovery in 2006 of bad debts written off previously Deduct write-offs for (P90,000 + P60,000) Balance at December 31, 2006, before additional impairment loss Increase in estimated uncollectible accounts during 2006 (P235,300 - P175,000) Balance at December 31, 2006, adjusted (Schedule 1) P130,000 180,000 15,000 P325,000 150,000 P175,000 60,300 P235,300 Schedule 1: Computation of Allowance for Doubtful Accounts at December 31, 2006 Aging category November-December 2006 July-October January-June Prior to 1/1/06 a Balance P1,140,000 600,000 400,000 70,000 a Percent 10 25 75 Doubtful accounts P 22,800 60,000 100,000 52,500 P235,300 P130,000 - P60,000 Requirement (2) Flores Corporation Journal Entry December 31, 2006 Bad Debt Expense Allowance for Doubtful Accounts To increase the allowance for doubtful accounts at December 31, 2006, resulting 60,300 60,300 8-14 Solutions Manual to Accompany Applied Auditing, 2006 Edition from evaluation of collectibility of remaining receivables 8-15 Visayas Company Requirement (a) Visayas Company Accounts Receivable 12.31.06 Balance, 12.31.05 Add: Sales on account for the year Total Less: Collections during the year - with discount (1) - without discount (2) Accounts written off Credit memo for sales returns & allowances P 546,400 2,622,832 P3,169,232 P2,050,859 848,118 18,700 37,000 Balance, 12.31.06 Total collections Less: Accts paid w/ discount Accts paid by customers w/o discount 2,954,677 P 214,555 P2,857,960 2,009,842 (÷ 98% = P2,050,859) (1) P 848,118 (2) Requirement (b) AJE (1) Doubtful accounts expense Allowance for doubtful accounts 6,599 6,599 Supporting Analysis: % allowance to AR 12.31.05 Required % allowance to AR 12.31.06 Required allowance 12.31.06 2% x P214,555 = 3% 2/3 x 3% = 2% P4,291 Allowance for doubtful accounts balance, 12.31.05 Less: Accounts written off Required balance, 12.31.06 P 16,392 P546,400 P 16,392 18,700 P( 2,308) 4,291 Substantive Tests of Receivables and Sales Estimated bad debts expense for 12.31.06 8-16 8-15 P 6,599 Charry Company Requirement (a) Adjusting Journal Entries (1) (2) (3) (4) (5) (6) (7) (8) Accounts Receivable Customers’ accounts with credit balances (P500 + P5,000) 5,500 Sales Accounts Receivable 5,000 Subscriptions Receivable Accounts Receivable 15,000 Deposit on Contract Accounts Receivable 15,000 Claims Receivable Accounts Receivable 500 Advances to Employees Accounts Receivable 500 Advances to Affiliated Company Accounts Receivable Advances to Supplier Accounts Receivable 5,500 5,000 15,000 15,000 500 500 10,000 10,000 5,000 5,000 Requirement (b) Balance Sheet Presentation 12-31-06 Current Assets Accounts Receivable - Trade Claims Receivable Advances to Employees Advances to Supplier P59,500 500 500 5,000 Investments Advances to Affiliated Company 10,000 Other Assets Deposit on Contract 15,000 Shareholders’ Equity 8-16 Solutions Manual to Accompany Applied Auditing, 2006 Edition Subscribed Share Capital (net of subscriptions receivable of P15,000) xxx Supporting Analysis: Charry Company Accounts Receivable -Trade 12-31-06 Balance per ledger Add (Deduct) Adjustments: AJE (1) To reclassify accounts with credit balances (2) To reverse entry for consignment deliveries (3) To reclassify subscriptions receivable (4) To reclassify deposit on contract (5) To reclassify balance of claims from carrier for shipping damages (6) To reclassify employee’s IOU’s (7) To reclassify advances to affiliate (8) To reclassify advances to supplier Net adjustments P105,000 5,500 ( 5,000) ( 15,000) ( 15,000) ( 500) ( 500) ( 10,000) ( 5,000) ( 45,500) Balance as adjusted P 59,500 If correct entries were made for the transactions given, the Accounts Receivable account would show the following postings: Accounts Receivable Jan Balance Charge Sales Recoveries of accounts written off P 56,000 625,000 1,000 P682,000 P682,000 8-17 Collections Write offs Merchandise returns Allowance for shipping damages Balance Dec 31 P615,000 3,500 2,500 1,500 P622,500 59,500 P682,000 The Preston Companies (amounts in P millions) Requirement (1) (a) Preston’s earnings would have increased (1 – 0.40) P105 million or P63 million in 2006 Net accounts receivable and total assets would have been Substantive Tests of Receivables and Sales 8-17 P105 million higher than actually reported in 2006 Ignoring differences between tax and financial reporting, income tax payable would have increased by P0.40 (P105 million) or P42 million, and retained earnings would be greater by P63 million This example illustrates the material effect estimated bad debts can have on reported earnings and total assets (b) Under the allowance method, failure to write off an account has no effect on earnings (assuming a sufficient balance exists in the allowance account), or any net balances in the balance sheet Only the components of net accounts receivable would be affected Both gross accounts receivable and the allowance for doubtful accounts would be overstated P0.6 million Requirement (2) Beginning allowance balance Bad debt expense Ending allowance balance Write-offs of accounts 1998 P183 105 (212) P 76 Requirement (3) (a) The ratio of bad debt expense to operating revenue for the two years is: 2006, P105/P3,729 = 2.8%; 2005, P81/P3,534 = 2.3% This ratio appears relatively stable although is increasing (b) The composite rate of uncollectible accounts as a percentage of gross accounts receivable = ending allowance balance/ending accounts receivable The ratio for 2006 is P212 / (P951 + P212) = 18.2%, and for 2005 is P183 / (P972 + P183) = 15.8% This ratio is less stable and also is increasing (c) Bad debt expense is considerably higher than the write-offs in 2006 The firm has experienced an increase in expected write-offs Apparently the firm expects an increase in bad debts, which is partially an estimate of future write-offs 8-18 Rain Company Requirement (1) Present value of the note: P150,000 x (PV1, 12%, 3) (0.71178) = P106,767 8-18 Solutions Manual to Accompany Applied Auditing, 2006 Edition Requirement (2) Correction and Collection Schedule: Date 1-1-2005 12-31-2005 12-31-2005 12-31-2006 12-31-2007 12-31-2007 Explanation and Interest Revenue Recorded originally at face amount Correction to restate to present value To accrue interest, P106,767 x 12% = P12,812 To accrue interest, P119,579 x 12% = P14,349 To accrue interest, P133,928 x 12% = P16,072* Collection on face amount, debit Cash – + + + – Note Receivable Change Balance P150,000 P 43,233 106,767 12,812 119,579 14,349 133,928 16,072 150,000 150,000 * Rounded 8-19 d The Josefina note is a short-term note and is reported at face value although the note can be recorded at present value The Nicole note is reported at present value: [(P20,000 + 5(0.3) (P20,000)] (PV1, 8%, 5) = P23,000 (0.68058) = P15,653 c The annual payment is computed as: P10,000 (PVA, 8%, 5) = P10,000 / 3.99271 = P2,505 Discounting this stream of payments at 9% yields cash proceeds of: P2,505 (PVA, 9%, 5) = P2,505 (3.88965) = P9,744 Total interest equals total payments less proceeds = (P2,505) – P9,744 = P2,781 8-20 b Interest receivable is recorded for one month c Maturity value P100,000 Discount P100,000 (0.10) (6/12) (5,000) Proceeds P 95,000 Luce Company (1) AJE: Sales returns and allowances Inventory 12.31.06 Accounts receivable Cost of sales 30,000 24,000 30,000 24,000 Income will decrease by P6,000 if the above AJE is made (2) Ans (c) AJE: Sales 10,000 Substantive Tests of Receivables and Sales Accounts receivable 8-19 10,000 Income was overstated by P10,000 Ans (3) Actual number of units sold to Mr Lazo was 320 Ans (4) 8-21 (a) P48,000 P150 (b) Correct receivable from Mr Lazo : 320 x P100 Per client Overstatement Ans (d) P 32,000 48,000 P 16,000 (5) Accounts receivable from Mr Sia is correctly stated because the goods are considered sold in 2006 Ans (a) (6) Ans (d) ETC Co Adjusting Journal Entries AJE Cash Other Current Liabilities (UCPB Overdraft) 225,000 225,000 Accounts Receivable Cash 37,500 Cash Accounts Payable 28,709 Notes Payable Interest Expense Cash 67,500 16,200 Cash – BPI Other Current Liabilities (UCPB Overdraft) 25,000 Cash – SBTC Accounts Receivable 73,690 37,500 28,709 83,700 73,690 Cash 5.31.06 Per books AJE 25,000 P 15,825,000 225,000 (37,500) 28,709 8-20 Solutions Manual to Accompany Applied Auditing, 2006 Edition (83,700) 25,000 73,690 Adjusted balance P16,056,199 Accounts Receivable 5.31.06 AJE Subsidiary Ledger P8,047,054 37,500 (1) (c) General Ledger P7,868,029 37,500 (73,690) (375,215) 122,500 P7,831,839 P7,831,839 (2) (b) Allowance for Doubtful Accounts Aging Distributio n Current Past due: – 30 31 – 60 61 – 90 Over 90 Subsidiary Ledger P1,737,690.00 + P122,500 = P1,860,190.00 x = P 37,203.80 P1,617,340.00 P1,437,706.50 P1,474,450.00 P1,779,867.50 + P37,500 _ – P375,215 (3) (a) P8,047,054.00 8-22 % Amount Estimated to be Uncollectible = 1,617,340.00 x = 80,867.00 = 1,437,706.50 x 10 = 143,770.70 = 1,474,450.00 x 15 = 221,167.50 = 1,442,152.50 x 20 = 288,430.50 P7,831,839.00 P771,439.50 Ling, Inc Requirement (1) LING, INC Long-term Receivables Section of Balance Sheet December 31, 2005 9% note receivable from sale of division, due in annual installments of P500,000 to May 1, 2007, less current installment 8% note receivable from officer, due December 31, 2007, collaterized by 10,000 shares of Ling, Inc., ordinary shares with a fair value of P450,000 Non-interest-bearing note from sale of patent, net of 15% imputed interest, due April 1, 2007 P 500,000 [1] 400,000 84,105 [2] Substantive Tests of Receivables and Sales Installment contract receivable, due in annual installments of P50,000 to July 1, 2009, less current installment Total long-term receivables 8-21 112,400 [3] P1,096,505 Requirement (2) LING, INC Selected Balance Sheet Balances December 31, 2005 Current portion of long-term receivables: Note receivable from sale of division Installment contract receivable Total P500,000 [1] 27,600 [3] P527,600 Accrued interest receivable: Note receivable from sale of division Installment contract receivable Total P 60,000 [4] 11,200 [5] P 71,200 Requirement (3) LING, INC Interest Income from Long-Term Receivables and Gains Recognized on Sale of Assets For the Year Ended December 31, 2005 Interest income: Note receivable from sale of division Note receivable from sale of patent Note receivable from officer Installment contract receivable from sale of land Total interest income for year ended 12/31/05 P105,000 8,505 32,000 11,200 P156,705 Gains recognized on sale of assets: Patent Land Total gains recognized for year ended 12/31/05 P 37,600 [8] 50,000 [9] P 87,600 Explanation of amounts: [1] Long-term Portion of 9% Note Receivable at 12/31/05 Face amount, 5/1/00 Less: installment received 5/1/05 Balance, 12/31/05 P1,500,000 (500,000) P1,000,000 [6] [2] [7] [5] 8-22 Solutions Manual to Accompany Applied Auditing, 2006 Edition Less: installment due 5/1/06 Long-term portion, 12/31/05 (500,000) P 500,000 [2] Non-interest-bearing Note, Net of Imputed Interest at 12/31/05 Face amount, 4/1/05 P 100,000 Less: imputed interest [P100,000 – (P100,0000 x 0.756)] (24,400) Balance, 4/1/05 P 75,600 Add: interest earned to 12/31/05 (P75,600 x 15% x 9/12) 8,505 Balance, 12/31/05 P 84,105 [3] Long-term Portion of Installment Contract Receivable at 12/31/05 Contract selling price, 7/1/05 P 200,000 Less: down payment, 7/1/05 (60,000) Balance, 12/31/05 P 140,000 Less: installment due 7/1/06 [P50,000 – (P140,000 x 16%)] (27,600) Long-term portion, 12/31/05 P 112,400 [4] Accrued Interest – Note Receivable, Sale of Division, at 12/31/05 Interest accrued from 5/1 to 12/31/05 (P1,000,000 x 9% x 8/12) P 60,000 [5] Accrued Interest – Installment Contract at 12/31/05 Interest accrued from 7/1 to 12/31/05 (P140,000 x 16% x ½) P 11,200 [6] Interest Income – Note Receivable, Sale of Division, for 2005 Interest earned from 1/1 to 5/1/05 (P1,500,000 x 9% x 4/12) P 45,000 Interest earned from 5/1 to 12/31/05 (P1,000,000 x 9% x 8/12) 60,000 Interest income P 105,000 [7] Interest Income – Note Receivable, Officer, for 2005 Interest earned 1/1 to 12/31/05 (P400,000 x 8%) [8] Gain Recognized on Sale of Patent Stated selling price Less: imputed interest Actual selling price (P100,000 x 0.756) Less: cost of patent (net) P 32,000 P 100,000 (24,400) [2] P 75,600 8-23 Substantive Tests of Receivables and Sales Carrying value 1/1/05 Less amortization 1/1 to 4/1/06 (P8,000 x ¼) Gain recognized P40,000 (2,000) P [9] Gain Recognized on Sale of Land Sale of price Less: cost Gain recognized 8-23 (38,000) 37,600 P 200,000 (150,000) P 50,000 Grande Company Requirement PAS 39, paragraph 63 will be applied in this case On December 31, 2006, Grande Company should record the 2006 accrued interest and the impairment: Notes / Interest Receivable (0.06) (100,000) Interest Income 6,000 6,000 Bad Debts Expense Allowance for decline in note value 55,537 * 55,537 * Carrying value of note and interest (100,000 + 6,000) Present value / New carrying value of note (discount rate – 6%) Principal: Due on 12.31.08 (P30,000 x 0.89000) P26,700 Due on 12.31.10 (P30,000 x 0.79209) 23,763 Impairment write-down P106,000 50,463 P 55,537 Requirement The entries with the corresponding computations follow: Effective Interest Method December 31, 2007 Allowance for decline in note value Interest income (0.06) (50,463) December 31, 2008 Allowance for decline in note value Interest income (0.06) (50,463 + 3,028) Cash Notes receivable 3,028 3,028 3,209 3,209 30,000 30,000 8-24 Solutions Manual to Accompany Applied Auditing, 2006 Edition December 31, 2009 Allowance for decline in note value Interest income (0.06) (50,463 + 3,208 + 3,209 – 30,000) 1,602 1,602 December 31, 2010 Allowance for decline in note value Interest income * 0.06 (26,700 + 1,602) 1,698* 1,698 Cash * Notes receivable 30,000 Allowance for decline in note value Notes receivable To close remaining balance in notes receivable and allowance 46,000 30,000 46,000 * At this point, the amortized cost of the notes receivable is zero Notes Receivable 100,000 30,000 6,000 30,000 106,000 60,000 46,000 bal 8-24 Allowance for Decline in Note Value 3,028 55,537 3,209 1,602 1,698 9,537 55,537 46,000 Amy Corporation Requirement Accounts Receivable (Trade) Accounts Receivable (Officer) Ordinary Shares Subscriptions Receivable Advances to Employees Notes Receivable (Trade) Deposit to Guarantee Contract Performance Utility Deposit Receivables 15,500 3,600 12,000 1,800 6,000 5,000 500 44,400 Requirement Accounts receivable (trade) current asset, trade receivable Accounts receivable (officer) normally current nontrade receivable Ordinary shares subscription receivable current or noncurrent asset, depending on due date; nontrade receivable Substantive Tests of Receivables and Sales 8-25 8-25 Advances to employees current asset, nontrade receivable Notes receivable (trade) noncurrent asset, trade receivable Deposit to guarantee contract performance separately classify, could be current or noncurrent asset, depending on the length of the contract; nontrade receivable Utility deposit separately classify, probably noncurrent nontrade receivable Jane’s Department Store Requirement Age Under 30 days 30- 60 days 61-120 days 121-240 days 241-360 days Over 360 days Balance P193,000 114,000 73,000 41,000 25,000 19,000 P465,000 Estimated Percentage Uncollectible 0.008 0.020 0.050 0.200 0.350 0.600 Estimated Amount Uncollectible P 1,544 2,280 3,650 8,200 8,750 11,400 P35,824 Requirement a 35,824 Bad Debt Expense (P35,824 + P3,000) Allowance for Doubtful Accounts 38,824 Bad Debt Expense (P35,824 – P2,800) Allowance for Doubtful Accounts 33,024 b Bad Debt Expense Allowance for Doubtful Accounts c 8-26 35,824 38,824 33,024 Blue Corporation Requirement 2005 Dec Dec 1 11 Cash [(P175,000 x 0.80) – P1,400] 138,600 Assignment Service Charge Expense (P175,000 x 0.80 x 0.01) 1,400 Notes Payable (P175,000 x 0.80) 140,000 Accounts Receivable Assigned Accounts Receivable 175,000 Sales Returns and Allowances Accounts Receivable Assigned 175,000 1,000 1,000 8-26 Solutions Manual to Accompany Applied Auditing, 2006 Edition 31 31 2006 Jan 29 29 29 Cash Accounts Receivable Assigned 86,000 Notes Payable Interest Expense (P140,000 x 0.12 x 1/12) Cash 86,000 Cash Accounts Receivable Assigned 60,000 86,000 1,400 87,400 60,000 Notes Payable (P140,000 – P86,000) 54,000 Interest Expense (P54,000 x 0.12 x 1/12) 540 Cash 54,540 Accounts Receivable Accounts Receivable Assigned (P175,000 – P1,000 – P86,000 – P60,000) 28,000 28,000 Requirement On the December 31, 2005 balance sheet of the Blue Corporation, the assigned accounts receivable and the remaining liability would be reported as follows: 8-27 Current Assets: Accounts receivable assigned P88,000 Current Liabilities: Note payable P54,000 Tandy Shoes Sept 15 21 29 Accounts Receivable Credit Card Expense (P2,100 x 0.05) Sales Sales Returns and Allowances Accounts Receivable Credit Card Expense (P200 x 0.05) Cash Accounts Receivable 1,995 105 2,100 200 190 10 1,805 1,805 Substantive Tests of Receivables and Sales 8-28 8-27 Gabe Company GABE COMPANY Income Statement Effect For the Year Ended December 31, 2005 Expenses resulting from accounts receivable assigned (Schedule 1) Expenses resulting from accounts receivable sold (P300,000 – P260,000) Total expenses P15,100 40,000 P55,100 Schedule 1: Computation of Expenses for Accounts Receivable Assigned Assignment expense: Accounts receivable assigned Advance by Belle Interest expense Total expenses P200,000 x 85% P170,000 x 3% P 5,100 10,000 P 15,100 ... ledger after agreeing to general ledger control account Prepared by: Initial Date & 8-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition Exhibit 1.2 Monty’s Meat, Inc Accounts Receivable... use a combination of negative and positive confirmations by sending the positives to accounts with large balances and negatives to those with small balances 8-3 It is acceptable to confirm accounts... auditor traced the ABC Grocery remittance of P3,000 to November cash receipts 8-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition 2) The workpaper does not state whether the auditor examined