Professional Documents
Culture Documents
Audit of Liabilities
The auditor’s objectives in the audit of liabilities are to ascertain:
Internal Control
1. Authorization of liabilities. Authorization should be required both for the incurring of
liabilities and the liquidation or payment of such liabilities. Such authorization is
necessary to assure that company’s commitment for obligations to creditors are made
after careful planning and study of company’s needs and those payments for such
obligations are within the company’s means. Failure to observe such control measures
can result to inability to pay maturing obligations which can lead to defaults and
eventually foreclosure of assets pledged as collaterals. Finally, this means loss of assets
in favour of the creditors.
In the case of purchases, payroll and other expenses, authorization and approvals are
indicated on the documents such as purchase requisitions, purchase orders, department
records and payroll sheets and expense vouchers. For major borrowing, authorization by
the Board of Directors is necessary. Sources of funding as well as the officer authorized
to negotiate loans should be specified in the corporate minutes.
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2. Records of liabilities should be maintained. Detailed records should be kept such as
voucher register, subsidiary accounts payable ledger, notes register, bond register and
other records. The system should also provide for adequate forms and documentations
such as prenumbered purchase orders, receiving reports, prenumbered notes, bonds,
etc. Such records are the sources of information as to how much will be paid and to
whom payment should be made. If there are discounts, the company should avail of
such discounts. Payments should be made when obligations are due to avoid incurring
additional cost of financing in the form of interest, fines and other charges. Prompt
payments likewise redound to company’s benefit in terms of establishing a good credit
standing. Subsidiary records should be reconciled periodically to general ledger
accounts. Any discrepancy should be investigated and properly taken up in the books.
4. Segregation of duties. To achieve effective internal controls over trade and other
payables, duties should be segregated so that a cash disbursement to a creditor will be
made only after involving the purchasing, receiving, accounting and finance
departments. The function of preparation of checks must be separated from the function
of check issuance to prevent irregularities on cash disbursements. Ideally, the individual
accounts in the subsidiary ledgers for accounts payable must be periodically reconciled
with monthly statements from vendors.
The most effective control over interest payments is created when the company assigns
the task of making interest payments to the trustee. The company then issues a single
check to the trustee for the periodic interest payments, and the trustee makes payments
to bondholders.
Frauds on Liabilities
1. Payments are made to fictitious creditors.
2. Liabilities are overstated and overpaid in connivance with creditors.
3. Notes are issued for unrecorded and unauthorized loans.
4. Proceeds from borrowing are misappropriated.
5. Interest rates are overstated, the difference pocketed.
Substantive Procedures
In the examination of liability accounts, the auditor normally includes the following audit
procedures:
1. Obtain schedules of liability accounts. In auditing liabilities, the first thing that the
auditor should do is to obtain schedules of the different liability accounts. The auditor
should request for a detailed list of the accounts payable to trade creditors, other
payables and accrued items. The amounts in the list should be compared with the
subsidiary ledger, voucher register or open voucher file, depending on the system
adopted by the enterprise. Any omission of book items from the list of balances or vice-
versa should be carefully examined and the journals and schedules checked for errors.
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When tracing schedules to subsidiary ledgers, the auditor should take note of
discrepancy in dates. The total of the schedules should be footed and traced to general
ledger controlling account. Schedules should be reconciled with the general ledger
controlling accounts. It is the client’s responsibility to see to it that the subsidiary ledger
and general ledger totals are reconciled or are in agreement.
Obtain schedules of notes payable. The auditor should be provided with a schedule of
each note or acceptances payable including details as follows:
a) Name of payee
b) Amount
c) Date
d) Maturity
e) Interest rate
f) Interest accrued
g) Interest paid
h) Interest prepaid
i) Interest expense
j) Endorsers and guarantors
k) Collaterals
Obtain schedules of mortgages and bonds payable. Schedules for mortgages and bonds
usually contain the following details:
a) Date of mortgages or bonds
b) Name and addresses of mortgages and bondholders
c) Property pledged or mortgaged including their locations
d) Original amount mortgaged or bonds authorized
e) Total installments paid during the period under audit
f) Date and amount of each installment paid during the period
g) Amount of unpaid balances at the end of the period
h) Maturity dates
i) Interest rates
j) Interest payment dates
k) Interest paid during the year
l) Accrued interest at the beginning of the year
m) Accrued interest at the end of the year
n) Interest expense for the year
o) Amortizations of bond discounts and bond premiums
p) Unamortized bond of discounts and premiums
2. Obtain confirmation of liabilities. The auditor should confirm payables on a test basis
to determine propriety of recorded balances and to detect unrecorded liabilities. The
routine procedures for receivables are applicable likewise to payables. The confirmation
form should be in the name of the client, the mailing should be made by the auditor in
envelopes which contain the auditor’s return address and with enclosed self-addressed
and postal paid return envelopes addressed to the auditor. The main difference between
confirmation request for receivable and payable is that in the confirmation request of
payables, the account balance per books is not shown instead; the creditor is requested
to fill in the amount.
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3. Vouch of transactions affecting liabilities and related accounts. Additions to or
deduction from the payable accounts should be traced to underlying records and
applicable substantiating documents. For accounts payable, it would include
examination of approved purchase requisition, purchase orders, purchase invoices,
freight bills, cancelled checks returned by banks, receiving reports, creditor’s monthly
statements and official receipts. For accrued liabilities, such as accrued rent, accrued
salaries, accrued commissions, etc., verification should be tied up with the examination
of the related expenses. These should be vouched to rental contracts, payroll sheets,
sales invoices, statement of commissions, lease agreements, cancelled checks,
authorizations, company policies and other supporting documents.
For notes payable and related interests, minutes of meetings for authorization should be
reviewed. Issuance of notes payable to bank should be substantiated by examination of
entry in the cash receipts books, inspection of bank credit memos, bank statement
entries and loan agreement entries. Payment on notes should be traced to bank debit
memos, cancelled notes and cancelled checks.
For bonds payable, the auditor should review corporate minutes for authorization, bond
indenture for information as to the nature of issue, authorized amounts, redemption
provision, among others. Likewise loan agreements with bondholders, bond certificate
book, trustees report, interest payments and other pertinent supporting data should be
verified on a test basis.
Accrued liabilities represent obligations payable sometime during the succeeding period
for services received before the reporting date. The basic auditing steps for accrued
liabilities are:
1. Examine any contacts or other documents that provide the basis for the accrual,
2. Appraise the accuracy of the detailed accounting records maintained for this
category of liability,
3. Identify and evaluate the reasonableness of the assumptions that underlie the
computation of the liability,
4. Test the computations made by the client in setting up the accrual, and
5. Determine that accrued liabilities have been treated consistently at the beginning
and end of the period,
6. Consider the need for accrual of other liabilities not yet recorded.
4. Search for unrecorded liabilities. The auditor will look for possible understatement of
liabilities. May audit steps are available to the auditor to find out understatement of
obligations. The understatement of obligation which at time may be intentional is
designed to show better financial position as when the client plans to influence creditors
in obtaining additional financing.
Cash payments made subsequent to the reporting date must be compared with items in
the accounts payable trial balance. These payments may show that certain liabilities
existed but were unrecorded at the end of the reporting period. The amount of interest
expense must be reviewed for reasonableness of the amount of interest bearing
liabilities. For clients following the voucher system, the unpaid vouchers file must
likewise be reviewed. Other documents, such as minutes of meetings, lease contracts,
statements of accounts from other entities may also indicate the existence of unrecorded
obligations.
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5. Obtain liability certificate from client. To obtain additional corroboration as further
substantiating evidence for the validity and legitimacy of liabilities and to impress upon
the client that it is directly responsible for the accuracy of the recorded amounts of
liabilities, the auditor should obtain from the client a liability certificate.
A liability certificate is a written assurance from the client, signed by a responsible official
of the company, stating that all known liabilities have been recorded and that contingent
liabilities have been disclosed.
Proper presentation of accounts payable requires that material amounts of accounts with
debit balances be reclassified as assets. Material amounts of payables to related parties
should be listed separately from accounts payable to trade creditors and the details of
the related transactions should be disclosed in a note to the financial statements in
compliance with PAS 24, Related Party Disclosures. Also, information about assets
pledged as collateral for the payables should be disclosed in the financial statements.
Illustrative Problems:
1. In the course of your audit of PROBE Inc. for the year ended December 31, 2014, you took
note of the following information:
f. Dividends in arrears on The company is yet to declare dividends since its last
cumulative preference shares, declared and distributed dividends in 2012.
P20,000
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g. Share dividends payable in
ordinary shares, P 37,200.
h. Liabilities under guarantee This pertains to PROBE’s guarantee of its
agreement, P 45,000 employees’ bank loans. As per past experience,
employees unlikely default on their loan payments.
u. Deferred tax liability, P 150,000 This refers to deferred tax liabilities on cumulative
temporary difference on taxable income and financial
income which will reverse over the next two years.
Required:
a) How much is the total current liabilities?
b) How much is the total noncurrent liabilities?
c) How much is the total liabilities?
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2. The accountant for Sierra Corporation prepared the following schedule of liabilities as of
December 31, 2015.
a) The bank notes payable include two separate notes payable to First Bank:
A P300,000, 8% note issued March 1, 2015, payable on demand. Interest is
payable each six months.
A 2-year, P500,000, 11.50% note issued January 2, 2014. On December 30,
2015, Sierra negotiated a written agreement with the First Bank to replace this
note with a 2-year, P500,000, 10% note to be issued January 2, 2016.
b) The 10% mortgage note was issued October 1, 2012, with a term of 10 years. Terms of
the note give the holder the right to demand immediate payment if the company fails to
make a monthly interest payment within 10 days of the date the payment is due. As of
December 31, 2015, Sierra is three months behind in paying its required interest
payment.
c) The 12% mortgage note was issued May 1, 2006, with a term of 20 years. Interest is due
annually on April 30.
d) The bonds payable are 10-year, 8% bonds, issued June 30, 2006.
Required:
Prepare the liabilities section of the December 31, 2015 classified statement of
financial position for Sierra Corporation. Include notes as appropriate. Assume
interest payable is computed correctly.
3. Char, Inc. inaugurated a new sales promotional program. For every 10 cereal box tops
returned to Char, customers will receive an attractive prize. Char estimates that only 30% of
the cereal box tops reaching the customer will be redeemed.
Units Amounts
Sale of cereal boxes 2,000,000 P 24,000,000
Purchase of prizes 36,000 180,000
Prizes distributed to customer 28,000
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The accountant of Char, Inc. journalized the purchase of prizes as a debit to premium
expense and a credit to cash. He just prepared a memo entry for prizes distributed.
Required:
Prepare any necessary audit adjusting entries.
4. In July 2014, Ever, your client, was sued for damages to an adjacent property as a result of
construction being made on its property. On December 31, 2014, it was estimated that it is
probable that Ever will have to pay damages amounting to P1,750,000. On February 1,
2015, prior to the issuance of your audit report and the company’s financial statements, the
plaintiff agreed to a settlement of P1,200,000.
In September 2014, Kent filed a suit against Ever Company alleging violation of patent rights
and it is seeking payment of damages of P7,000,000. Ever disclaims the charges and the
legal counsel is of the opinion that the chance of Ever paying any damages is remote.
In October 2014, Mr. Santos, a shareholder of Ever brought action against the company
seeking for P1,000,000 in damages. It is reasonably possible that Mr. Santos will be
successful but the amount of damages Evergreen will have to pay cannot be reasonably
estimated.
In November 2014, Ever Company became involved in a lawsuit. It is highly probable that
Ever will have to pay an amount between P1,600,000 and P2,000,000 but a better estimate
is P1,800,000, as a result of this lawsuit.
During 2014, the company was a defendant to a number of lawsuits as a result of a product
that is alleged to have harmful effects. The product was already withdrawn from the market.
It is probable that the company will have to pay for damages in the amount of P1,200,000 to
P1,800,000. Each point within the range is as likely as any other point.
Evergreen Company sold goods with a warranty under which customers are covered for the
cost of repairs from defects that become apparent within one year from date of purchase. If
only minor defects were detected in all products sold, repair costs of P1,000,000 would
result. If major defects were detected in all products sold, repair costs of P5,000,000 would
result.
The company's experience and future expectations indicate that for the coming year, 60% of
the goods sold will have no defects, 30% will have minor defects and 10% will have major
defects.
Required:
Compute the amount to be accrued at the end of 2014 and prepare the necessary adjusting
entries. Evergreen has not yet recorded any amount of obligation as a result of the
foregoing.
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5. SM Department Store sells gift certificates redeemable only when merchandise is
purchased. These gift certificates have an expiration date of two years after issuance date.
The unearned revenue account relating to gift certificates has a beginning balance of
P65,000 and the sale of gift certificates during the year 2014 was likewise credited to this
account. The balance of the unearned revenue account as at yearend totaled P300,000,
before any adjustment for the recognition of revenue. .
You verified that during the year, P15,000 worth of gift certificates expired and the total of
gift certificates that were redeemed was P200,000.
Required:
Compute for the correct balance of the account Unearned Revenue for Gift Certificates
outstanding as at December 31, 2014, and prepare the necessary adjusting entries.
6. In conjunction with your firm’s examination of the financial statements of Batur, Inc. as of
December 31, 2014, you obtained the information from the company’s voucher register
shown in the work paper below:
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15 1/12/2015 1-8 Merchandise, shipped FOB
destination, 1/3/2015; received 38,000 Inventory
1/10/2015
16 1/13/2015 1-9 Maintenance services; received Repairs &
1/9/2015 9,000 Maintenance
17 1/14/2015 1-10 Interest on bank loan, 10/10/2014 –
1/10/2015 30,000 Interest expense
18 1/15/2015 1-11 Manufacturing equipment; installed 254,000 Machinery &
12/29/2014 equipment
19 1/15/2015 1-12 Dividends declared, 12/15/2014 160,000 Dividends payable
The accrued payroll and accrued interest were reversed effective January 1, 2015.
Required:
Review the data given above and prepare journal entries to adjust the accounts on
December 31, 2014. Assume that the company follows FOB terms for recording inventory
purchases.
PREMIUMS
The premium is offered on the recorded and sheet music. Customers receive a coupon
for each P 10 spent on recorded music and sheet music. Customers may exchange 200
coupons and P 200 for a CD player. YOURDARLING pays P 340 for each CD player and
estimates that 60% of the coupons given to customers will be redeemed. A total of 6,500 CD
players used in the premium program were purchased during the year and there were
1,200,000 coupons redeemed in 2014.
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 worked totaled
P1,640,000 during 2014.
YOURDARLING uses the accrual method to account for the warranty and premium costs for
financial reporting purposes. YOURDARLING’s sales for 2014 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, 2014, were shown below:
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Based on the preceding information, determine the amounts that will be shown on the
2014 financial statements for the following:
Warranty expense
Estimated liabilities from warranties
Premium expense
Inventory of premium CD players
Estimated premium claims outstanding
8. From the following accounts and supplementary information, prepare working papers and
any adjusting entries covering your audit of bonds payable in connection with your first
examination of the YOURBABY Corporation, as of December 31, 2012:
Bond Premium
Debit Credit Balance
January 1, 2008 P 25,000 P 25,000
CR
Treasury Bonds
Debit Credit Balance
October 1, 2012 P 104,500 P 104,500
CD
The treasury bonds were purchased at a price of P 103 plus accrued interest through a
broker. The bonds are not be reissued and the client asked you to prepare an adjusting
entry writing off the bonds.
Required:
a) Analyses as of December 31, 2012
Bonds Payable
Bonds Premium
Accrued interest payable
Bond interest expense
b) Adjusting entries as of December 31, 2012
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9. You are examining the records of the YOURHONEY Corporation for the year ended
December 31, 2014. This is the first time the company has been audited. The Company
floated a serial bond issue in 2012. The details of the issue and the accounts as of
December 31, 2014 are presented below:
You are required to prepare working papers for the affected accounts and a list of
adjusting journal entries as of December 31, 2014.
10. The following data were obtained from the initial audit of Jordan Company:
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Accrued Interest Payable
Debit Credit Balance
Balance, January 1, 2014 P 75,000 P 75,000
Accrual, December 31, 2014 75,000 150,000
Treasury Bonds
Debit Credit Balance
Redemption price and interest
to date on 200 bonds
permanently retired –
December 31, 2014 P 255,000 P 255,000
11. The following data were obtained from the initial audit of the YOURLOVE Company:
Treasury Bonds
Debit Credit Balance
Redemption price and interest
to date on 100 bonds
permanently retired – October P 109,000 P 109,000
1, 2014
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a) Adjusted balances as of December 31, 2014 of
Bonds Premium
Accrued interest payable
Bond interest expense
b) Composition of payment to retire bonds
c) Loss on bond redemption
12. On December 31, 2013, Ford Company issued 5,000 of its 8%, 10-year, P1,000 face value
bonds with detachable share warrants at 110. Each bond carried a detachable warrant for
ten ordinary shares of Ford Company at a specified option price of P25 per share. The par
value of the ordinary share is P20.
Immediately after issuance, the market value of the bonds without the warrants was
P5,400,000 and the market value of the warrants was P600,000.
In the December 31, 2013 statement of financial position, what is the carrying amount
of bonds payable?
13. On December 31, 2013, Lucio Company issued P5,000,000 face value, 5-year bonds at
109. Each P1,000 bond was issued with 50 detachable warrants, each of which entitled the
bondholder to purchase one ordinary share of P5 par value at P25. Immediately after
issuance, the market value of each warrant was P5.
The stated interest rate on the bonds is 11% payable annually every December 31.
However, the prevailing market rate of interest for similar bonds without warrants is 12%.
The present value of 1 at 12% for 5 periods is 0.57 and the present value of an ordinary
annuity of 1 at 12% for 5 periods is 3.60.
14. The accounting profit before tax for the year ended December 31, 2014 for Chico
Corporation amounted to P175,900 and included: Interest income, P11,000; Long-service
leave expense, P7,000; Doubtful debt expense, P4,200; Depreciation – plant (15% p.a.),
P33,000; Rent expense, P22,800; and Entertainment expense – nondeductible, P3,900.
The draft statement of financial position at December 31, 2014 contained the following
assets and liabilities:
2014 2013
Cash P 9,000 P 7,500
Accounts receivable 83,000 76,800
Allowance for doubtful accounts (5,000) (3,200)
Inventory 67,100 58,300
Interest receivable 1,000 -
Prepaid rent 2,800 2,400
Plant 220,000 220,000
Accumulated depreciation – plant (99,000) (66,000)
Deferred tax asset ? 30,360
Accounts payable 71,200 73,600
Provision for long-service leave 64,000 61,000
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Deferred tax liability ? 720
Additional information:
The tax depreciation rate for plant is 10% p.a., straight-line.
The tax rate is 30%.
The company has P15,000 in tax losses carried forward from previous year.
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