AUDITING

1. In pursuing a firm’s quality control objectives, a firm should adopt policies and procedures to
enable it to identify and evaluate circumstances and relationships that create threats or reduce
them to an acceptable level by applying safeguards, or, if considered appropriate, to withdraw
from the engagement. Which quality control element would be most likely to satisfy?
A. Monitoring
B. Human resources
C. Ethical requirements
D. Leadership responsibilities for quality within the firm

2. A candidate who fails in to complete CPA Board Examinations shall be disqualified from taking
another set of examination unless he or she submits evidence to the satisfaction of the Board
that he or she enrolled in and completed at least
A. 16 units of subjects given in the licensure examination
B. 18 units of subject given in the licensure examination
C. 21 units of subject given in the licensure examination
D. 24 units of subject given in the licensure examination

3. Which of the following statements does not properly describe a limitation of an audit?
A. Many financial statement assertions cannot be audited
B. The work undertaken by the auditor is permeated by judgment
C. Fatigue and human weakness can cause auditors to overlook pertinent evidence
D. Many audit conclusions are made on the basis of examining a sample of evidence

4. The objective of the ordinary examination by the independent auditor is the expression of an
opinion on
A. The accuracy of the annual report
B. The fairness of the financial statements
C. The accuracy of the financial statements
D. The balance sheet and income statement

5. Before accepting an engagement to audit a new client, a CPA is required to obtain

A. The prospective client’s signature to the engagement letter
B. An understanding of the prospective client’s industry and business
C. A preliminary understanding of the prospective client’s control environment
D. The prospective client’s consent to make inquiries of the predecessor auditor, if any

6. Engagement letter that documents and confirms the auditor’s acceptance of the engagement
would normally be sent to the client
A. At the end of fieldwork
B. After the audit report is issued
C. Before the audit report is issued
D. Before the commencement of the engagement

7. The audit risk model is

A. A planning, testing, and evaluation model
 B. Useful in evaluating results but of limited use in planning
C. Useful in planning, but of limited value in evaluating results
D. Useful when performing the tests of balances, but of little value in either the planning or
evaluation stages

8. Which of the following discoveries by the auditor would NOT raise the red flag of increased
inherent risk?
A. Client is a parent company with a subsidiary
B. A bond indenture requires a current ratio of at least three to one
C. Management bonuses are based on a percentage of net income
D. Client makes extensive use of notes receivable and notes payable rather than buying and
selling on open account basis

9. The relationship between materiality and audit risk is

A. Direct C. Inverse
B. Indirect D. Parallel

10. The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement
2. Estimate the total misstatement in the segment
3. Set preliminary judgment about materiality to segments
4. Allocate preliminary judgment about materiality to segments
5. Compare combined estimate with preliminary judgment about materiality
A. 1, 2, 5, 4, 3 C. 4, 3, 1, 5, 2
B. 3, 4, 2, 1, 5 D. 5, 1, 3, 2, 4

11. The auditor’s risk assessment procedures should always include the following, except
A. Analytical procedures
B. Observation and inspection
C. Substantive test procedures and test of controls
D. Inquiries of management and of others within the entity

12. The overall objective of internal auditing is to

A. Ascertain that controls are cots justified
B. Attest the efficiency with which resources are employed
C. Provide assurance that financial data have been accurately recorded
D. Assist the members of the organization in the effective discharge of their responsibilities

13. The responsibility for the detection and prevention of errors, fraud and non-compliance with
laws and regulations rests with
A. Auditor
B. Audit committee
C. Internal audit department
D. Management and those charged with governance

14. __________ is an intentional misstatement or omission of amounts or disclosures with the

intent to deceive the readers of the financial statements
A. An error
 B. Fraudulent financial reporting
C. Misappropriation of assets
D. None of the above is correct

15. If there is a risk of material misstatement resulting from fraud that may involve or result in
improper revenue recognition, it would be appropriate for the auditor to
A. Withdraw from the engagement
B. Express a qualified opinion or an adverse opinion
C. Confirm with customers certain relevant contract terms
D. Propose adjusting entry in order to reverse the amount of revenue

16. Arroyo Company reported the following events during the year ended December 31, 2020:

 It was decided to write off P800,000 from inventory which was over two years old as it was
obsolete.
 Sales of P600,000 had been omitted from the financial statements for the year ended December
31, 2019.

What total amount should be reported as prior period error in the financial statements for the year
ended December 31, 2020?

a. 1,400,000
b. 600,000
c. 800,000
d. 200,000

Answer: b

Only the unrecorded sale of P600,000 on December 31, 2019 is treated as prior period error in the 2020
financial statements. The write-off of the inventory of P800,000 is included in 2020 profit or loss.

17. The draft financial statements for Angelica Company for the years ended December 31,
2021 had prepared. A final review of the draft revealed an overvaluation of the ending
inventory of P2,000,000 on December 31, 2020. Further investigation showed that there
was an overvaluation of ending inventory on December 31, 2019 of P1,200,000. What
adjustment should be made to the profit for the year ended December 31, 2020 presented
as the comparative figure in the 2021 financial statements?

a. 2,000,000 decrease
b. 1,200,000 decrease
c. 800,000 decrease
d. 0

Answer: c

Overvaluation of December 31, 2020 inventory (2,000,000)

Overvaluation of December 31, 2019 inventory 1,200,000

Net decrease in 2020 profit (800,000)

18. Tagyamon Company had determined the 2020 and 2021 net income to be P4,000,000
and
P5,000,000, respectively. In a first time audit of the financial statements, the following errors are
discovered:

 Merchandise inventory was incorrectly determined – P50,000 overstatement for 2020 and
P150,000 overstatement for 2021.
 Revenue received in advance in 2020 of P300,000 was credited to a revenue account when
received. Of the total, P50,000 was earned in 2020, P200,000 was earned in 2021 and the
remainder will be earned in 2022.
 P400,000 gain on sale of plant asset in 2021 were erroneously credited to retained earnings.

What is the corrected net income for 2021?

a. 5,500,000
b. 5,450,000
c. 5,400,000
d. 5,550,000

Answer: a
2020 2021
Net income per book 4,000,000 5,000,000
Overstatement of inventory
2020 (50,000) 50,000
2021 (150,000)
Revenue received in advance (250,000) 200,000
Gain on sale of plant asset 400,000

Corrected net income 3,700,000 5,500,000

19. On December 31, 2020, Cristobal Company sold merchandise for P750,000 to Santisimo
Company. The terms of the sale were net 30, FOB shipping point. The merchandise was
shipped on December 31, 2020 and arrived at Santisimo on January 5, 2021. Due to a clerical
error, the sale was not recorded until January 2020 and the merchandise sold at a 25%
markup on cost was included in Cristobal’s inventory at December 31, 2020. What was the
effect of the errors on cost of goods sold for 2020?

a. Understated by P750,000
b. Understated by P600,000
c. Understated by P150,000
d. Correctly stated

Answer: b
The December 31, 2020 inventory was overstated. Therefore, cost of goods sold for 2020 was
understated by P600,000 (750,000 / 125%)
20. During 2022, Gomburza Company discovered that the ending inventories on tis financial
statements were incorrect by the following amounts:

2020 P120,000 understated

2021 150,000 overstated

Gomburza uses the periodic system to ascertain year-end quantities that are converted to peso amounts
using FIFO cost method.

Prior to any adjustments for these errors and ignoring income taxes, how much would be the
accumulated profits and losses of Gomburza at January 1, 2022?
a. Correct
b. P30,000 overstated
c. P150,000 overstated
d. 270,000 overstated

Answer: c
 The understatement of 2020 ending inventories no longer affects the January 1, 2022
accumulated profits and losses/retained earnings since inventory error is a “self-correcting
error” or known as a counterbalancing error. A counter-balancing error corrects itself after two
years of having the error not detected/corrected. Counter-balancing errors normally include the
misstatement of (a) inventory including purchases and sales; (b) prepaid expenses; (c) accruals of
expenses and income; and (d) deferred revenues.
 Ending inventory of 2020 (asset) was overstated; as a result, net income for 2021 was overstated
which will be carried over to the beginning balance of accumulated profits and losses/retained
earnings for 2022.

21. While examining the December 31, 2020 financial statements of Villena Company, you
discover
the following:
a. Inventory at January 1, 2020 had been overstated by P30,000.
b. Inventory at December 31, 2020 was understated by P50,000.
c. During 2020, Villena received a P100,000 cash advance from a customer for merchandise to be
manufactured and shipped during 2020. The amount was credited to sales revenue.
d. The net income reported on the 2020 profit or loss before reflecting any adjustments for the
above items is P3,000,000.

What is the corrected net income for the year ended December 31, 2020?
a. 2,920,000
b. 2,980,000
c. 3,040,000
d. 3,080,000
Answer: b

Reported net income 3,000,000

a. Overstatement of January 1, 2020 inventory 30,000
b. Understatement of December 31, 2020 inventory 50,000
c. Sales for 2021 recognized in 2020 (100,000)
Correct net income, 2020 2,980,000
 Overstatement of the January 1, 2020 inventory overstates cost of sales resulting to an
understatement of net income.
 Understatement of the December 31, 2020 inventory overstates cost of sales resulting to an
understatement of net income.
 A sale for 201 recognized in 2020 overstates current year (2020) sales resulting to an
overstatement of net income.

22. On December 30, 2020, Moya Corporation sold merchandise for P750,000 to Vergara
Company. The terms of the sale were n/30, FOB shipping point. The merchandise was
shipped on December 31, 2020 and arrived at Vergara Company on January 2, 2021. Due to
a clerical error, the sale was not recorded until January 2021. Due to a clerical error, the sale
was not recorded until January 2021 and the merchandise, sold at a 25% markup on cost,
was included in Moya’s inventory at December 31, 2020. As a result, Moya’s cost of goods
sold for the year ended December 31, 2020 was –

a. Understated by P15,000
b. Understated by P60,000
c. Understated by P75,000
d. Correctly stated

Answer: b

The December 31, 2020 inventory was overstated. Therefore, cost of goods sold for 2020 was
understated by P60,000 (75,000 ÷ 125%).
23. Baltazar Company discovered the following errors in its financial records at the beginning of
the year 2022:
a. The physical inventory count on December 31, 2021 excluded a merchandise with a cost of
P38,000 that had been temporarily stored in a public warehouse. Baltazar uses the periodic
inventory system.
b. During 2021, a competitor filed a patent infringement suit against Baltazar claiming damages of
P440,000. The company’s legal counsel has indicated that an unfavorable verdict is probable and
a reasonable estimate of the court’s award to the competitor is P250,000. The company has not
reflected or disclosed this situation in the financial statements.
c. A trademark was acquired at the beginning of 2020 for P100,000. No amortization has been
recorded since acquisition. It is the company’s policy to amortize all intangibles with a definite
life for a maximum of 20 years. At the time of acquisition, the trademark was estimated to have
a definite life of 20 years.
What is the effect of the above errors on the January 1, 2022 accumulated profits?
a. 214,500 overstated
b. 217,000 overstated
c. 222,000 overstated
d. 293,000 overstated

Answer: c
Accumulated Profits,
Jan. 1 2022
Under (Over)
A. Company’s inventory, excluded in the physical count 38,000
B. Failure to recognize a probable and reasonable amount
of estimated loss (250,000)
C. Failure to amortize trademarks (P100,000 ÷ 20 x 2) (10,000)
Net effect (222,000)

24. Visayas Company reported a Retained earnings balance of P400,000 at December 31, 2020.
In August 2021, Visayas Company determined that insurance premiums of P75,000 for the
three-year period beginning January 1, 2020, had been paid and fully expensed in 2020.
Assume Visayas has a 32% income tax rate. What amount should Visayas report as adjusted
beginning Retained earnings in 2021?
a. 366,000
b. 425,000
c. 434,000
d. 450,000

Answer: c

Accumulated profits, December 31, 2020 400,000

Overstatement of expense 50,000
x Net of tax income 68% 34,000
Adjusted accumulated profits, January 1, 2021 434,000

For items 25 to 29:

Shown below is the bank reconciliation for Marikina Company for November 2020:

Balance per bank, Nov. 30, 2020 P150,000

Add: Deposits in transit 24,000
Total 174,000
Less: Outstanding checks P28,000
Bank credit recorded in error 10,000 38,000
Cash balance per books, Nov. 30, 2020 P136,000
The bank statement for December 2020 contains the following data:

Total deposits P110,000

Total charges, including an NSF check of P8,000
And a service charge of P400 96,000

All outstanding checks on November 30, 2020, including the bank credit, were cleared in the bank in
December 2020.

There were outstanding checks of P30,000 and deposits in transit of P38,000 on December 31, 2020.

QUESTIONS:

Based on the above and the result of your audit, answer the following:
25. How much is the cash balance per bank on December 31, 2020?
a. P154,000 c. P164,000
b. P150,000 d. P172,400

26. How much is the December receipts per books?

a. P124,000 c. P110,000
b. P96,000 d. P148,000

27. How much is the December disbursements per books?

a. P96,000 c. P89,600
b. P79,600 d. P98,000

28. How much is the cash balance per books on December 31, 2020?
a. P150,000 c. P180,400
b. P170,400 d. P162,000

29. The adjusted cash in bank balance as of December 31, 2020 is

a. P141, 500 c. P172,000
b. P162,000 d. P196,000

Answer: 1) C; 2) A; 3) B; 4) C; 5: C

Suggested Solution:

Question No. 25

Balance per bank, Nov. 30, 2020 P150,000

Add: Total deposits per bank statement 110,000
Total 260,000
Less: Total charges per bank statement 96,000
Balance per bank, Dec. 31, 2020 P164,000

Question No. 26
 Total deposits per bank statement P110,000
Less: deposits in transit, Nov. 30 24,000
Dec. receipts cleared through the bank 86,000
Add: deposits in transit, Dec. 31 38,000
December receipts per books P124,000

Question No. 27

Total charges per bank statement P96,000

Less: Outstanding checks, Nov. 30 P28,000
Correction of erroneous bank credit 10,000
December NSF check 8,000
December bank service charge 400 46,400
Dec. disb. cleared through the bank 49,600
Add: outstanding checks, Dec. 31 30,000
December disbursements per books P79,600

Question No. 28

Balance per books, Nov. 30, 2020 P136,000

Add: December receipts per books 124,000
Total 260,000
Less: December disbursements per books 79,600
Balance per books, Dec. 31, 2020 P180,400

Question No. 29

Balance per bank statement, 12/31/20 P164,000

Deposits in transit 38,000
Outstanding checks (30,000)
Adjusted bank balance, 12/31/20 P172,000

Balance per books, 12/31/20 P180,400

NSF check (8,000)
Bank service charges (400)
Adjusted book balance, 12/31/20 P172,000

For items 30 to 32:

On January 1, 2019, Cabiao Corporation purchased a tract of land (site number 1010) with a building for
P1,800,000. Additionally, Cabiao paid a real estate broker’s commission of P108,000, legal fees of
P18,000 and title guarantee insurance of P54,000. The closing statement indicated that the land value
was P1,500000 and the building value was P300,000. Shortly after acquisition, the building was razed at
a cost of P225,000.
Cabiao entered into a P9,000,000 fixed-price contract with Cabanatuan Builders, Inc. on March 1, 2019
for the construction of an office building on the land site 101. The building was completed and occupied
on September 30, 2020. Additional construction costs were incurred as follows:

Plans, specifications and blueprints P36,000

Architect’s fees for design and supervision 285,000

The building is estimated to have a forty-year life from date of completion and will be depreciation using
the 150%-declining-balance method.

To finance the construction cost, Cabiao borrowed P9,000,000 on March 1, 2019. The loan is payable in
ten annual installments of P900,000 plus interest at the rate of 14%. Cabiao used part of the loan
proceeds for working capital requirements. Cabiao’s average amounts of accumulated building
construction expenditures were as follows:

For the period March 1 to December 31, 2019 P2,700,000

For the period January 1 to September 30, 2020 6,900,000

Cabiao is using the allowed alternative treatment for borrowing cost.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

30. Cost of land site number 101

a. P1,905,000 c. P2,205,000
b. P1,800,000 d. P2,151,000

31. Cost of office building

c. P10,581,000 c. P10,329,000
d. P10,360,500 d. P10,960,500

32. Depreciation of office building for 2020

a. P96,800 c. P102,800
b. P97,130 d. P99,197

Answers: 1) C; 2) B; 3) B

Suggested Solution:

Questions No. 30

Acquisition cost P1,800000

Real estate broker’s commission 108,000
Legal fees 18,000
Title guarantee insurance 54,000
Cost of razing the existing building 225,000
Total cost of land site 101 P2,205,000
Question No. 31

Fixed-price contract cost P 9,000,000

Plans, specifications and blueprints 36,000
Architect’s fees and design supervision 285,000
Capitalizable borrowing cost:
Mar. 1 to Dec. 31, 2019
(P2,700,000 x 14% x 10/12) P315,000
Jan. 1 to Sept. 30, 2020
(P6,900,000 x 14% x 9/12) 724,500 1,039,500
Total cost of office building P10,360,500

Question No. 32

Depreciation expense [P10,360,500 x (1/40x1.5) x 3/12] P97,130

For items 33 to 36:

The adjusted trial balance of Galimuyod Company as of December 31, 2019 shows the following:

Debit Credit
Accounts receivable P1,000,000
Allowance for bad debts P40,000

Additional information:

 Cash sales of the company represents 10% of gross sales.

 90% of the credit sales customers do not take advantage of the 2/10, n/30 terms.

 It is expected that cash discount of P6,000 will be taken on accounts receivable outstanding at
December 31, 2020.

 Sales returns in 2020 amounted to P400,000. All returns were from charge sales.

 During 2020, accounts totaling to P44,000 were written off as uncollectible; bad debt recoveries
during the year amounted is P3,000.

 The allowance for bad debts is adjusted so that it represents certain percentage of the
outstanding accounts receivable at year end. The required percentage at December 31, 2020 is
150% of the rate used on December 31, 2019.

QUESTIONS:

Based on the above and the result of your audit, answer the following:

33. The accounts receivable as of December 31, 2020 is

a. P3,000,000 c. P333,333
 b. P300,000 d. P2,444,000

34. The allowance for doubtful accounts as of December 31, 2020 is

a. P20,000 c. P180,000
b. P120,000 d. P146,640

35. The net realizable value of accounts receivable as of December 31, 2020 is
a. P307,340 c. P2,874,000
b. P2,814,000 d. P2,291,360

36. The doubtful account expense for the year 2020 is

a. P181,000 c. P21,000
b. P121,000 d. P147,640

Answers: 1) A; 2) C; 3) B; 4) A

Suggested Solution:

Question No. 33

Expected cash discounts P 6,000

Divide by percentage of cash discount 0.02
Portion of AR that will be granted cash discounts 300,000
Divide by percentage of total AR estimated to
take advantage of the discount 0.10
Accounts receivable, 12/31/20 P3,000,000

Question No. 34

Accounts receivable, 12/31/20 P3,000,000

Multiply by bad debt rate
[(P40,000 / P1,000,000) x 1.5] 0.06
Allowance for doubtful accounts, 12/31/20 P 180,000

Question No. 35

Accounts receivable, 12/3/20 P3,000,000

Less: Allowance for doubtful accounts P180,000
Allowance for sales discounts 6,000 186,000
Net realizable value, 12/31/20 P2,814,000

Question No. 36

Allowance for doubtful accounts, 12/31/20 P180,000

Add: accounts written off 44,000
Total 224,000
Less: Allowance for doubtful accounts, 12/31/20 P40,000
Bad debt recoveries 3,000 43,000
 Doubtful accounts expense for 2020 P181,000

For items 37 to 40:

Guinayangan Co. purchases land and constructs a service station and car wash for a total of P6,750,000.
At January 2, 2020, when construction is completed, the facility and land on which it was constructed
are sold to a major oil company for P7,500,000 and immediately leased from the oil company by
Guinayangan. Fair value of the land at time of the sale was P750,000. The lease is a 10-year
noncancelable lease. The agreement requires equal rental payments at the end of each year beginning
December 31, 2020. The interest rate implicit in the lease is 10%. Guinayangan uses straight-line
depreciation for its other various business holdings. The economic life of the facility is 15 years with zero
salvage value. Title tot the facility and land will pass to Guinayangan at termination of the lease.

QUESTIONS:

Based on the above and the result of your audit, answer the following: (Round off present value factors
to four decimal places.)

37. The amount of annual lease payment is

a. P1,098,526 c. P976,467
b. P1,220,584 d. P1,109,632

38. The total lease-relate expenses to be recognized by the lessee during 2020 is
a. P1,000,000 c. P1,075,000
b. P1,425,000 d. P1,200,000

39. The total lease-related income to be recognized by the lessee during 2020 is
a. P75,000 c. P750,000
b. P50,000 d. P 0

40. The total lease-related income to be recognized by the lessor during 2020 is
a. P675,000 c. 750,000
b. P600,000 d. P 0

Answers: 1) B; 2) D; 3) A; 4) C

Suggested Solution:

Question No. 37

Cost of facility (purchase price) P7,500,000

Divide by (PV of ordinary annuity of P1 at
 10% for 10 periods) 6.1446
Annual lease payment P1,220,584

Question No. 38

Interest expense (P7,500,000 x 10%) P750,000

Depreciation expense
(P7,500,000 – P750,000 / 15) 450,000
Total P1,200,000

Question No. 39

Selling price P7,500,000

Less: cost of facility 6,750,000
Gain on sale and leaseback 750,000
Divide by lease term 10
Gain to be recognized in 2020 P 75,000

If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the
carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it shall be
deferred and amortized over the lease term. (PAS 17 par. 59)

Question No. 40

Interest income in 2020 (P7,500,000 x 10%) P750,000