AUDIT OF LIABILITIES

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 CPA REVIEW SCHOOL OF THE PHILIPPINES AP 9502-1
Manila
AUDITING PROBLEMS
CPA Review
AUDIT OF LIABILITIES
(Part 1 of 2)

PROBLEM 1 – PUKPOK, INC.

PUKPOK, INC. is a manufacturer and retailer of household furniture. Your audit of the company’s
financial statements for the year ended December 31, 2024, discloses the following debt
obligations of the company at the end of its reporting period. Pukpok’s financial statements are
authorized for issuance on March 31, 2025.

1. A P500,000 short-term obligation due on March 1, 2025. Its maturity could be extended to
March 1, 2027, provided Pukpok agrees to provide additional collateral. On February 12,
2025, an agreement is reached to extend the loan’s maturity to March 1, 2027.

2. A short-term obligation of P1,200,000 in the form of notes payable due February 5, 2025.
The company issued 7,500 ordinary shares for P120 per share on January 25, 2025. The
proceeds from the issuance, plus P300,000 cash, were used to fully settle the debt on
February 5, 2025.

3. A P1,500,000 note payable due July 31, 2025. Pukpok intends to refinance the note by
issuing long-term bonds. On January 10, 2025, the company prepaid P200,000 of the note
because the company temporarily had excess cash. A P2,000,000 bond offering was
completed in March 2025. The proceeds will be used to repay the note payable at maturity.

4. Deferred serial bonds, issued at face value of P5,000,000, and bearing interest at 12%. The
bonds are payable in semiannual installment of P500,000 due April 1 and October 1 of each
year. The last bond is to be paid on October 1, 2030. The interest is also paid semiannually.

5. A long-term obligation of P4,000,000. The loan is maturing over 8 years in the amount of
P500,000 per year. The loan is dated September 1, 2024, and the first maturity date is
September 1, 2025.

6. A debt obligation of P600,000 maturing on December 31, 2027. The debt is callable on
demand by the lender at any time.

7. A P2,000,000,10% mortgage note issued October 1, 2023 with a term of 10 years. The
terms of the note give the holder the right to demand immediate payment if the entity fails
to make a monthly interest payment within 10 days of the date the payment is due. On
December 31, 2024, Pukpok is three months behind in making the required interest
payment. An agreement was reached to provide a waiver of the breach on January 31,
2025.

8. Bank notes payable which include two separate notes payable to Beckla Bank:
a. A P3,000,000, 10% note issued March 1, 2023, payable on demand. Interest is payable
every 6 months.
b. A one-year, P5,000,000, 11% note issued January 2, 2024. On December 31, 2024,
Pukpok negotiated a written agreement with Beckla Bank to replace the note with a 5-
year, P5,000,000, 10% note to be issued January 2, 2025.

9. A P4,000,000, 10-year, 8% bonds issued at par on June 30, 2015. Interest is payable
annually on June 30 and December 31.

10. A P1 million, 10% note due on March 31, 2029. The financing agreement contains a
covenant that requires Pukpok to maintain current assets at least equal to 200% of its

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CPAR - MANILA AP 9502-1 – AUDIT OF LIABILITIES

current liabilities. As of December 31, 2024, Pukpok has breached this loan covenant. On
February 10, 2025, Pukpok obtained a period of grace from Mayo Bank until January 31,
2026, having convinced the bank that the company’s normal 3 to 1 ratio of current assets
to current liabilities will be reestablished during 2025.

11. P2 million 10% bonds issued at face value on December 31, 2005. The bonds mature on
December 31, 2034, but bondholders have the option to call (demand payment on) the
bonds on December 31, 2025. However, the call option is not expected to be exercised,
given prevailing market conditions.

Questions:

1. What amount of current liabilities should be reported on the December 31, 2024, statement
of financial position?

2. What amount of noncurrent liabilities should be reported on the December 31, 2024,
statement of financial position?

PROBLEM 2 – HANDUSAY COMPANY

15%, 10-year, Bonds Payable, dated January 1, 2023

Debit Credit Balance
Cash proceeds from issue on
January 1, 2023, of 1,000,
P1,000 bonds. The market rate
of interest on the date of issue
was 12%. P1,172,044 P1,172,044

Bond Interest Expense

Cash paid, 1/2/24 P 75,000 P 75,000
Cash paid, 7/1/24 75,000 150,000
Accrual, 12/31/24 75,000 225,000

Accrued Interest on Bonds

Balance, 1/1/24 P 75,000 P 75,000
Accrual, 12/31/24 75,000 150,000

Treasury Bonds
Redemption price and interest to
date on 200 bonds permanently
retired on Dec. 31, 2024 P265,000 P265,000

Based on the preceding information, determine the following:

1. Carrying value of bonds payable at December 31, 2024

A. P831,110 C. P1,151,583
B. P800,000 D. P921,266

2. Loss on bond redemption

A. P4,683 C. P15,000
B. P19,683 D. P34,683

3. Accrued interest on bonds at December 31, 2024

A. P75,000 C. P60,000
B. P135,000 D. P52,500

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CPAR - MANILA AP 9502-1 – AUDIT OF LIABILITIES

4. Bond interest expense for the year ended December 31, 2024
A. P150,000 C. P69,745
B. P139,174 D. P160,826

PROBLEM 3 – TOROTOT MUSIC EMPORIUM

TOROTOT MUSIC EMPORIUM carries a wide variety of musical instruments, sound reproduction
equipment, recorded music, and sheet music. To promote the sale of its products, Torotot uses
two promotion techniques—premiums and warranties.

PREMIUMS
The premium is offered on the recorded and sheet music. Customers receive a coupon for each
P10 spent on recorded music and sheet music. Customers may exchange 200 coupons and P200
for a power bank. Torotot pays P340 for each power bank and estimates that 60% of the coupons
given to customers will be redeemed. A total of 6,500 power banks used in the premium program
were purchased during the year and there were 1,200,000 coupons redeemed in 2024.

WARRANTIES
Musical instruments and sound reproduction equipment are sold with a one-year warranty for
replacement of parts and labor. The estimated warranty cost, based on past experience, is 2%
of sales. Replacement parts and labor for warranty work totaled P1,640,000 during 2024.

Torotot uses the accrual method to account for the warranty and premium costs for financial
reporting purposes. Torotot’s sales for 2024 totaled P72,000,000—P54,000,000 from musical
instruments and sound reproduction equipment and P18,000,000 from recorded music and sheet
music. The balances in the accounts related to warranties and premiums on January 1, 2024,
were as shown below:
Inventory of power banks P 399,500
Estimated premium claims outstanding 448,000
Estimated liability from warranties 1,360,000

Based on the preceding information, determine the amounts that will be shown on the 2024
financial statements for the following:

1. Warranty expense
A. P1,640,000 B. P1,080,000 C. P800,000 D. P360,000

2. Estimated liability from warranties

A. P1,920,000 B. P1,080,000 C. P240,000 D. P800,000

3. Premium expense
A. P1,836,000 B. P840,000 C. P756,000 D. P2,189,500

4. Inventory of power banks

A. P399,500 B. P569,500 C. P2,210,000 D. P739,500

5. Estimated premium claims outstanding

A. P364,000 B. P840,000 C. P756,000 D. P672,000

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CPAR - MANILA AP 9502-1 – AUDIT OF LIABILITIES

MULTIPLE CHOICE QUESTIONS

1. In auditing accounts payable, an auditor’s procedures most likely will focus primarily on
management’s assertion of
A. Existence
B. Presentation and disclosure
C. Completeness
D. Valuation and allocation

2. An auditor performs a test to determine whether all merchandise for which the client was
billed was received. The population for this test consists of all
A. Merchandise received
B. Vendors’ invoices
C. Canceled checks
D. Receiving reports

3. The primary audit test to determine if accounts payable are valued properly is
A. Confirmation of accounts payable.
B. Vouching accounts payable to supporting documentation.
C. An analytical procedure.
D. Verification that accounts payable was reported as a current liability in the balance sheet.

4. Which of the following procedures is least likely to be performed before the balance sheet
date?
A. Observation of inventory count.
B. Testing of internal control over cash.
C. Search for unrecorded liabilities.
D. Confirmation of receivables.

5. An audit assistant found a purchase order for a regular supplier in the amount of P5,500.
The purchase order was dated after receipt of goods. The purchasing agent had forgotten
to issue the purchase order. Also, a disbursement of P450 for materials did not have a
receiving report. The assistant wanted to select additional purchase orders for investigation
but was unconcerned about lack of receiving report. The audit director should
A. Agree with the assistant because the amount of the purchase order exception was
considerably larger than the receiving report exception.
B. Agree with the assistant because the cash disbursement clerk had been assured by the
receiving clerk that the failure to fill out a report didn’t happen very often.
C. Disagree with the assistant because two problems have an equal risk of loss associated
with them.
D. Disagree with the assistant because the lack of a receiving report has a greater risk of
loss associated with it.

6. When using confirmation to provide evidence about completeness assertion for accounts
payable, the appropriate population most likely is
A. Vendors with whom the entity has previously done business.
B. Amounts recorded in the accounts payable subsidiary ledger.
C. Payees of checks drawn in the month after the year end.
D. Invoices filed in the entity’s open invoice file.

7. Which of the following is a substantive test that an auditor is most likely to perform to verify
the existence and valuation of recorded accounts payable?
A. Investigating the open purchase order file to ascertain that pre-numbered purchase
orders are used and accounted for.
B. Receiving the client’s mail, unopened, for a reasonable period of time after year end to
search for unrecorded vendor’s invoices.
C. Vouching selected entries in the accounts payable subsidiary ledger to purchase orders
and receiving reports.
D. Confirming accounts payable balances with known suppliers who have zero balances.
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CPAR - MANILA AP 9502-1 – AUDIT OF LIABILITIES

8. Unrecorded liabilities are most likely to be found during the review of which of the following
documents?
A. Unpaid bills
B. Shipping records
C. Bills of lading
D. Unmatched sales invoices

9. Which of the following audit procedures is best for identifying unrecorded trade accounts
payable?
A. Reviewing cash disbursements recorded subsequent to the balance sheet date to
determine whether the related payables apply to the prior period.
B. Investigating payables recorded just prior to and just subsequent to the balance sheet
date to determine whether they are supported by receiving reports.
C. Examining unusual relationships between monthly accounts payable balances and
recorded cash payments.
D. Reconciling vendors’ statement to the file of receiving reports to identify items received
just prior to the balance sheet date.

10. Which of the following procedures relating to the examination of accounts payable could
the auditor delegate entirely to the client’s employees?
A. Test footings in the accounts payable ledger.
B. Reconcile unpaid invoices to vendors’ statements.
C. Prepare a schedule of accounts payable.
D. Mail confirmations for selected account balances.

11. An audit plan for noncurrent liabilities should include steps that require
A. Examining bond trust indentures.
B. Inspecting the accounts payable subsidiary ledger.
C. Investigating credits to the bond interest income account.
D. Verifying the existence of bondholders.

12. In connection with an audit of bonds payable, an auditor expects to find in the trust
indenture the
A. Description of the collateral.
B. The issuer’s debt-to-equity ratio at the time of issuance.
C. Effective yield of the bonds issued.
D. Subscription list.

13. During an audit of an issuer of bonds, the auditor should obtain written confirmation
regarding debenture transactions from the
A. Internal auditors.
B. Trustee.
C. Client’s attorney.
D. Debenture holders.

14. During its fiscal year, a company issued, at a discount, a substantial amount of first-
mortgage bonds. When performing audit work concerning this bond issue, the independent
auditor should
A. Inspect the records maintained by the bond trustee.
B. Trace the net cash received from the issuance to the bonds payable account.
C. Review the minutes for authorization.
D. Confirm the existence of the bondholders.

15. The auditor is most likely to verify accrued commissions payable in conjunction with the
A. Sales cutoff test.
B. Examination of trade accounts payable.
C. Verification of contingent liabilities.
D. Review of disbursements subsequent to the balance sheet date.

--- END ---

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 CPA REVIEW SCHOOL OF THE PHILIPPINES AP 9502-2
Manila
AUDITING PROBLEMS CPA Review

AUDIT OF LIABILITIES
(Part 2 of 2)

PROBLEM NO. 1

In connection with the audit of the DORA BELLS COMPANY for the year ended December 31,
2024, you are called upon to verify the accounts payable transactions. You find that the company
does not make use of a voucher register but enters all merchandise purchases in a Purchases
Journal, from which postings are made to a subsidiary accounts payable ledger. The subsidiary
ledger balance of P1,500,000 as of December 31, 2024, agrees with the accounts payable balance
in the company’s general ledger. An analysis of the account disclosed the following:

Trade creditors, credit balances P1,363,000

Trade creditors, debit balances 63,000
Net 1,300,000
Estimated warranty on products sold 100,000
Customers’ deposits 9,000
Due to officers and shareholders for advances 50,000
Goods received on consignment at selling price
(offsetting debit made to Purchases) 41,000
P1,500,000

A further analysis of the “Trade Creditors” debit balances indicates:

Date Item Amount

Miscellaneous debit balances prior to 2020.
No information available due to loss of
records in a fire. P 3,000

03/03/2022 Swiper Co. – Merchandise returned for credit,

but the company is now out of business. 8,000

06/10/2023 Map Corp. – Merchandise returned, but

Map says “never received.” 7,000

07/10/2024 Backpack Distributors – Allowance granted on

defective merchandise after the invoice
was paid. 5,000

10/10/2024 Boots Co. – Overpayment of invoice. 12,000

12/05/2024 Advance to Nagawa Co. This company agrees

to supply certain articles on a cost-plus basis. 24,000

12/05/2024 Goods returned for credit and adjustments on

price after the invoices were paid; credit
memos from suppliers not yet received. 4,000
P63,000
Your next step is to check the invoices in both the paid and the unpaid invoices files against
ledger accounts. In this connection, you discover an invoice from Diego Bells Co. of P45,000
dated December 12, 2024, marked “Duplicate” which was entered in the Purchases Journal in
January 2025. Upon inquiry, you discover that the merchandise covered by this invoice was
received and sold, but that the original invoice apparently has not been received.
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CPAR - MANILA AP 9502-2 – AUDIT OF LIABILITIES

In the bank reconciliation working papers, there is a notation that five checks totaling P63,000
were prepared and entered in the Cash Disbursements Journal of December, but these checks
were not issued until January 10, 2025.

The inventory analysis summary discloses goods in transit of P6,000 at December 31, 2024, not
taken up by the company under audit during the year 2024. These goods are included in your
adjusted inventory.

Questions:

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

1. The Accounts payable – Trade balance at December 31, 2024, should be

A. P1,471,000 B. P1,614,000 C. P1,214,000 D. P1,477,000

2. The net adjustment to Purchases should include a

A. Net debit of P51,000.
B. Net credit of P41,000.
C. Net debit of P10,000.
D. Net debit of P73,000.

3. The entry to adjust the Accounts payable account for those accounts with debit balances
should include a debit to Miscellaneous losses of
A. P18,000 B. P23,000 C. P35,000 D. P39,000

4. The entry to adjust the Accounts payable account for those accounts with debit balances
should include a debit to
A. Miscellaneous losses of P23,000.
B. Advances to suppliers of P24,000.
C. Suppliers’ debit balances of P18,000.
D. Purchases of P21,000.

5. Auditor confirmation of accounts payable balances at the end of the reporting period may
be unnecessary because
A. There is likely to be other reliable external evidence to support the balances.
B. Correspondence with the audit client’s attorney will reveal all legal action by vendors for
non-payment.
C. This is a duplication of cutoff test.
D. Accounts payable at the end of the reporting period may not be paid before the audit is
completed.

PROBLEM NO. 2

In the audit process, the following data were obtained from the books of the ARKEYUS COMPANY
which uses a voucher system. All invoices are subject to terms 2/10, n/30 and are entered net
with the discount entered in Purchase Discounts column of the voucher register. The accountant
in charge of the books went on leave to attend to his family based in California. A fresh
accountancy graduate has been assigned to record the transactions. At year-end, the substitute
accountant finds that the unpaid vouchers do not agree with the Vouchers Payable control
account. You are called to adjust the matter.

A schedule of unpaid vouchers as of December 31, 2024, all of which are net of discount, is
presented to you.

Page 2 of 3
CPAR - MANILA AP 9502-2 – AUDIT OF LIABILITIES

Date Voucher No. Supplier Amount

Nov. 27 797 Opis Supply Co. P 78,400
Dec. 02 821 Egimae Distributors 19,600
11 829 Plastek Sales 44,100
20 836 Parnichur Dealers 17,150
21 842 Nokbuk Merchandising 22,050
22 856 Hilo Mercantile 80,850
31 865 Palitan Traders 78,400
P340,550

Vouchers Payable (control account)

Cash disbursements P1,309,500 Purchases journal P1,645,000
Purchase returns journal 36,750*

* Voucher Nos. 821 and 836 canceled as goods were returned in December.

Questions:

Based on the above and the result of your audit, compute the following as of December 31, 2024:

1. Adjusted balance of Vouchers Payable

A. P310,000 B. P306,750 C. P303,800 D. P344,250

2. Purchase discounts lost on unpaid vouchers

A. P6,200 B. P2,950 C. P3,700 D. P 0

3. Purchase discounts lost on paid vouchers

A. P28,750 B. P8,000 C. P5,050 D. P41,800

4. The adjusting entry or entries to correct the accounts will include

A. A debit to Purchase Discounts Lost of P11,250.
B. A debit to Purchase Discounts Lost of P5,050.
C. A credit to Vouchers Payable of P8,000.
D. A credit to Vouchers Payable of P11,250.

PROBLEM NO. 3

On January 1, 2023, DIAS COMPANY issued 3-year, 4,000 convertible bonds at face value of
P1,000 per bond. Interest is to be paid annually in arrears at the stated coupon rate of 6%. Each
bond is convertible, at the holder’s option, into 200 P2 par value ordinary shares at any time up
to maturity. On the date of issuance, the prevailing market interest rate for similar debt without
the conversion privilege was 9%. On the same date, the market price of one ordinary share was
P3. The bonds were converted on December 31, 2024.

1. The equity component of the convertible debt is

A. P303,768 B. P1,973,621 C. P1,600,000 D. P2,400,000

2. The interest expense to be reported on Dias Company’s income statement for the year
ended December 31, 2024, is
A. P101,000 B. P110,107 C. P240,000 D. P341,000

3. The entry to record the bond conversion on December 31, 2024, should include a credit to
share premium – issuance of
A. P2,289,893 B. P2,400,000 C. P2,593,661 D. P 0

END OF 9502-2

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