CDD: Auditing Problems – Investments

COLEGIO DE DAGUPAN
Arellano St., Dagupan City

AUDITING PROBLEMS
INVESTMENTS IN EQUITY SECURITIES

INVESTMENTS
Are assets held by an entity for the accretion of wealth through distribution such as interest, royalties, dividends and
rentals, for capital appreciation or for other benefits to the investing entity such as those obtained through trading
relationships.

Equity instrument

Equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.

Examples of equity instruments:

• Ordinary shares
• Certain preference shares
• Warrants or written call options

An investment in equity security is a financial asset since it is an equity instrument of another entity.

Standards Applicable for Investments in Ordinary Shares

Types of Investment Purpose Method Applicable Standard
Financial asset PAS 39
Dividend/
PAS 32
Speculation Fair value
PFRS 7
(No significant influence)
PFRS 9*
Investment in Associate Influence Equity Method PAS 28
Investment in Joint Venture PAS 28
Joint control Equity Method
PFRS 11
Investment in Subsidiary PAS 27
Control Consolidation
PFRS 10
*2013 version of PFRS 9 is effective January 1, 2015, while its 2014 version is effective January 1, 2018.

INITIAL RECOGNITION
Financial assets are recognized on the Statement of Financial Position when the entity becomes party to the
contractual provisions of the instrument.

INITIAL MEASUREMENT
All financial assets are measured initially at fair value, plus, for those financial assets not classified at fair value
through profit or loss, directly attributable transaction costs.

INITIAL MEASUREMENT OF INVESTMENTS IN EQUITY SECURITIES

FVTPL FVTOCI Nonmarketable
Fair value Fair value Purchase price
Excluding transaction cost Including transaction cost Including transaction cost

SUBSEQUENT CLASSIFICATION AND MEASUREMENT

An entity shall classify financial assets as subsequently measured at either amortized cost or fair value on the basis
of both:
a) The entity’s Business Model for managing the financial assets
b) The Contractual Cash Flow Characteristics of the financial asset.

Option to designate at fair value (Fair Value Option)

An entity may, at initial recognition, designate a financial asset as measured at fair value through profit or loss if
doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an
‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognizing the gains and
losses on them on different bases.

Business Model Assessment

The assessment on the entity’s business model centers around whether financial asset are held for the collection of
contractual cash flows. This is based on how the entity is run, and on the objective of the business model as

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CDD: Auditing Problems – Investments
determined by key management personnel (per PAS 24 Related Party Disclosure). The assessment therefore is not on
an instrument by instrument basis – rather the overall business model of the entity

However, a single entity might have more than one business model, which may then result in different categories of
financial assets. Although the focus is on the collection of contractual cash flows, it is not necessary to hold all of the
assets to their contractual maturity. This means that sales of assets can occur without prejudicing the assertion that
they are held for the collection of contractual cash flows.

Contractual Cash Flow Characteristics

The assessment of the contractual terms for cash flows is carried out on an instrument by instrument basis.
Instruments with cash flows that are solely payments of principal and interest on the principal amount outstanding,
are classified at amortized cost. Interest on the principal amount outstanding is made up from consideration for the
time value of money and for the credit risk associated with the principal amount outstanding during a particular
period – and nothing else

For instruments denominated in foreign currency, the assessment is made on the basis of the currency in which the
instrument is denominated (FX movements between the foreign currency and functional currency are not taken into
account when analyzing the contractual terms).

Regular way purchases or sales of a financial asset

A regular way purchase or sale is a purchase or sale of a financial asset under a contract whose terms require delivery
of the asset within the time frame established generally by regulation or convention in the marketplace concerned.

A regular way purchase or sale of financial assets is recognized and derecognized using either trade date or
settlement date accounting. The method used is to be applied consistently for all purchases and sales of financial
assets that belong to the same category of financial asset as defined in PAS 39 (note that for this purpose assets held
for trading form a different category from assets designated at fair value through profit or loss). The choice of method
is an accounting policy.

What is trade date accounting?

Under trade date accounting, the financial asset and liability are recognized on the date the enterprise commits to the
purchase.

What is settlement date accounting?

Under settlement date accounting, the financial asset is recognized on the date it is delivered.

Summary of recognition and derecognition in a regular way purchase and sale of financial assets:

Trade Date Settlement Date

Recognize Commitment date Delivery date
Derecognize Commitment date Delivery date
Changes in FV from trade date to settlement date (for FA measured at FV):
Purchase Recognize Recognize
Sale Ignore Ignore

PROBLEM NO. 1 Sale: Trade Date vs. Settlement Date Accounting

On December 28, 2011, Brayden Company commits itself to purchase a financial asset to be classified as held for
trading for P800,000, its fair value on commitment (trade) date. This security has a fair value of P801,000 and
P802,000 on December 31, 2011 (Brayden's financial year-end), and January 5, 2012 (settlement date), respectively.

1. If Brayden applies the trade date accounting method to account for regular-way purchases of its securities, how
much should be recognized as trading securities on December 31, 2011?
a. P800,000 c. P802,000
b. P801,000 d. P 0

2. If Brayden applies the settlement date accounting method to account for regular-way purchases of its securities,
how much should be recognized as trading securities on December 31, 2011?
a. P800,000 c. P802,000
b. P801,000 d. P 0

PROBLEM NO. 2 Purchase: Trade Date vs. Settlement Date Accounting

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CDD: Auditing Problems – Investments
On December 28, 2011 (trade date), Luke Corp. enters into a contract to sell an equity security classified as available
for sale (AFS) for its current fair value of P303,000. The asset was acquired a year ago and its cost was P300,000. On
December 31, 2011 (financial year-end), the fair value of the asset is P303,600. On January 5, 2012 (settlement date),
the asset's fair value is P303,900.
1. If Luke uses the trade date method to account for regular-way sales of its securities, how much is the carrying
amount of AFS at December 31, 2011?
a. P303,000 c. P303,900
b. P303,600 d. P 0

2. If Luke uses the settlement date method to account for regular-way sales of its securities, how much is the
carrying amount of AFS at December 31, 2011?
a. P303,000 c. P900
b. P303,600 d. P 0

SUBSEQUENT MEASUREMENT
Nonmar-
FVTPL FVTOCI ketable
Measurement at reporting date Fair value Fair value Cost
Changes in Fair Value (Unrealized gains P/L OCI Ignore
or Loss) (Equity)

Note
 Unrealized holding gain or loss is also called paper gain or loss.
 The unrealized gain or loss that was recognized during the year for the Fair Value through Other comprehensive
Income is presented in the Statement of Other Comprehensive Income.
 The accumulated balance of unrealized gain or loss for the Fair Value through Other Comprehensive Income
(FVTOCI) is presented in the Statement Financial Position and Statement of Changes in Equity.

Computation of Unrealized Gains or Losses

FVTPL securities FVTOCI
Fair value (measurement date) XX Fair value (measurement date) XX
Less: Carrying value (Fair value previous reporting Less: Carrying value (Fair value previous reporting
date) XX date) XX
Unrealized gains or loss-P/L XX Unrealized gains or loss-SOCI XX

FVTOCI
Fair value (measurement date) XX
Less: Cost XX
Unrealized gains or loss - OCI XX

Gain or loss on derecognition

The gain or loss on derecognition is computed as the difference between:
a) the carrying amount (measured at the date of derecognition) and
b) the consideration received (including any new asset obtained less any new liability assumed) shall be recognized
in profit or loss.

Formula:
Consideration received xx
Less: Dividend acquired (dividend-on) xx
Transaction cost xx
Net selling price xx
Add: New asset obtained xx
Less: New liability assumed xx
Total xx
Less: Carrying amount (@ date of derecognition) xx
Gain (loss) on derecognition – P&L xx

Note:
 The dividend income of the investment sold is deducted from the consideration received if the entity sold the
investment in between the date of declaration and date of record of dividends.

PROBLEM NO. 3 Basic Journal Entries- Acquisitions in Between Dates of Declaration and Record
The Lurid Company has the following transactions relating to its investments during 2015:
January 5 Acquired 16,000 shares of Defray Co. for P1,600,000 paying additional P10,000 for brokerage and
another P5,000 for commission.
February 14: Received dividends from Defray Co. declared January 2, 2015 to the stockholder of record January 10,
2015, P16,000.

On December 31, 2015 the market values per share of the Defray stock is P95:

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CDD: Auditing Problems – Investments
On December 31, 2016 the market values per share of the Defray stock is P120.

Required: Prepare all the necessary entries assuming the investment is

1) Trading securities
2) Fair Value through Other Comprehensive Income securities

PROBLEM NO. 4 Derecognition of Financial Assets - Sale of Investment

On January 1, 2015, Haphazard Corp. owns 15,000 ordinary shares representing 15% of the shares outstanding of
Luke Corporation. The ordinary shares were acquired on November 12, 2014 at a cost of P750,000 and have a fair
value of P800,000 on December 31, 2014. On January 2, 2015, Haphazard sold half of its investment for P50 per share
incurring a brokerage and commission expense of P10,000.

Questions:
Based on the above data, answer the following:
Case No. 1: Assume that the above securities are classified as fair value through profit or loss
1. Unrealized gain (or loss) on December 31, 2014 to be presented in the statement of financial position.
a. Nil c. (50,000)
b. 50,000 d. 10,000

2. Gain (or loss) on sale on January 2, 2015.

a. Nil c. (25,000)
b. (35,000) d. 10,000

Case No. 2: Assume that the above securities are classified as fair value through other comprehensive income
3. Unrealized gain (or loss) on December 31, 2014 to be presented in the statement of financial position.
a. Nil c. (50,000)
b. 50,000 d. 10,000

4. Gain or loss on sale on January 2, 2015.

a. Nil c. (25,000)
b. (35,000) d. 10,000

5. Prepare all the necessary entries for the years 2014 and 2015 (for both FVTPL and FVTOCI).

DIVIDENDS OUT OF EARNINGS

1. Share Dividends
a. Same class Recorded as memorandum entry only
b. Different class Allocate the original cost using the relative fair value method. Journal entry
is(assuming Investment in preference shares were received):
Investment in Preference shares XX
Investment in Ordinary Shares XX

2. Cash dividends Recorded as income at the amount of cash receivable

3. Property dividends Recorded as income at the fair value of noncash Asset receivable at the date of
declaration.

4. Cash received in lieu As if the stocks were received and subsequently sold at the amount of cash received.
Stock dividend Gain or loss shall be recognized equal to the difference between the net selling price
and carrying value of the investment sold.
Carrying value = (CV before stock dividend/(Orig. shares +stock dividend) x stock
dividend)

5. Shares received in lieu of Income at the fair value of the stock received. In the absence of the FV, the income is
cash dividend equal to the cash dividends that would have been received.

DIVIDENDS OUT OF CAPITAL

Dividends out of capital are actually liquidating dividend. It is not an income and therefore credited to the investment
account.

Stock split Recorded as memorandum entry only. No income is recognized.

Special Recorded by a debit to Investment and credit to cash.
Assessment
Stock right
FVTPL Only memorandum entry
FVTOCI Record the stock rights at its FAIR VALUE by debit to Stock rights and credit to Unrealized gain
(P&L)
Classification This can be considered as derivative thus, presented as current
Assets.

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CDD: Auditing Problems – Investments
a. When SR The cost of investment includes
Is exercised FVTPL: only the subscription price
FVTOCI: a)subscription price plus
b. cost of the stock rights exercised.
b. When FVTOCI: Debit to loss on stock rights and credit stock rights.
Expired

Theoretical Value of the rights

a. When the stock is selling right-on:
Market value of stock right-on minus subscription price = Value of one right
Number of rights to purchase one share plus 1
b. When the stock is selling ex-right:
Market value of stock ex-right minus subscription price = Value of one right
Number of rights to purchase one share

PROBLEM NO. 5 Share Dividends

On October 1, 2015, Contentious Corp. owns 15,000 fair value through other comprehensive income shares at a cost of
P750,000. The shares represent 15% of the shares outstanding of Pulsate Corporation. The fair value of the ordinary
shares amounted to P50 per share.

Required:
Assume the following independent cases, record the receipt of the share dividends on the Contentious’ assuming:
Case No. 1: Contentious received 10% ordinary shares as Share Dividends.
Case No. 2: Contentious received 1,000 preference shares as Share Dividends. Each preference share has a fair value
of P100.

PROBLEM NO. 6 Cash Dividends

On December 1, 2015, Synthetic Corp. owns 15,000 ordinary shares representing 15% of the shares outstanding of
Prowess Corporation. During the same date Prowess declared P4 per share dividends on ordinary shares to the
shareholders of record on December 15 payable on December 31.

Questions:
Based on the above data, answer the following:
1. How much is the dividend income to be recognized in 2015?
a. Nil c. 30,000
b. 60,000 d. 15,000

2. Prepare all the necessary entries at the

a. Date of declaration
b. Date of Record
c. Date of Payment

PROBLEM NO. 7 Property Dividends

Doused Company owns 15% of the outstanding ordinary shares of Albeit Corp. On November 1, 2014, Albeit declared
its inventory as property dividends. Data relating to the fair values of the inventory follow:
Total Fair values
Date of Property Dividends
November 1, 2014 P500,000
December 31, 2014 P900,000
February 15, 2015 P820,000

Questions:
Based on the above data, answer the following:
1. How much is the dividend income to be recognized in 2014?
a. Nil c. 135,000
b. 75,000 d. 123,000

2. Prepare all the necessary entries on

a. November 1, 2014
b. December 31, 2014
c. February 15, 2015

PROBLEM NO. 8 Stock Right

On June 15, 2015, Mars Company owns 10,000 shares with a cost of P700,000 of Moon Company’s stocks. During the
same period, Moon Company issued stock rights to existing shareholders. Mars received 10,000 stock rights entitling
him to purchase 5,000 new shares at P80. The ordinary share was trading ex-rights at P80 a share and the rights had
a market value P20 per right.

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CDD: Auditing Problems – Investments

On July 15, 2015, Mars exercised all the stock rights. The share is quoted right-on at P90.

Questions:
Based on the above data, answer the following:
1. Assuming that the above securities are FVTPL, the stock rights should be initially recognized at
a. Nil c. 100,000
b. 200,000 d. 150,000

2. Assuming that the above securities are FVTOCI, the stock rights should be initially recognized at
a. Nil c. 100,000
b. 200,000 d. 150,000

3. Assuming that the above securities are FVTPL, the cost of investment acquired through exercised of stock rights
should be
a. Nil c. 600,000
b. 400,000 d. 200,000

4. Assuming that the above securities are FVTOCI, the cost of investment acquired through exercised of stock rights
should be
a. Nil c. 600,000
b. 400,000 d. 200,000

PROBLEM NO. 9 Theoretical Value of Rights

On January 2, 2015, Jupiter Company purchased 10,000 shares of P100 par value ordinary shares at P120 per share of
Saturn Company. On March 2, 2015, Saturn Company issued stock rights to its shareholders. The holder needs five
rights to purchase one share of ordinary stock at par. The market value of the stock on that date was P160 per share.
There was no quoted price for the rights.

Questions:
Based on the above data, answer the following:
1. Compute for the theoretical value of the rights assuming, the stock is selling right-on
a. Nil c. 12
b. 10 d. 27

2. Compute for the theoretical value of the rights assuming, the stock is selling ex-right
a. Nil c. 12
b. 10 d. 27

EXCHANGE OF ONE FINANCIAL ASSET INTO ANOTHER FINANCIAL ASSET (FOR EXAMPLE CONVERSION OF
INVESTMENT IN CONVERTIBLE PREFERENCE SHARES)
Paragraph 3.2.1 of PFRS 9 provides that if, as a result of a transfer, a financial asset is derecognized in its entirety but
the transfer results in the entity obtaining a new financial asset or assuming a new financial liability, or a servicing
liability, the entity shall recognize the new financial asset,
Fair value of the new financial asset XX
Less carrying amount (or cost) of the old financial asset XX
Gain or loss on exchange XX

The journal entry would be:

Financial Asset-new (at its fair value) XX
Loss on exchange (if any) XX
Gain on exchange (if any) XX
Financial asset (old) XX

RECLASSIFICATIONS OF INVESTMENTS IN EQUITY SECURITIES

No reclassifications to and from equity securities are allowed since equity securities are classified as FVTOCI, which is
prohibited from reclassification.

COMPREHENSIVE PROBLEMS
PROBLEM NO. 10 Trading Securities

You were able to obtain the following ledger details of Trading Securities in connection with your audit of the MUND
Corporation for the year ended December 31, 2011:

Date Particulars DR CR

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CDD: Auditing Problems – Investments
Date Particulars DR CR
Jan. 10 Purchase of FRANZ Co. – 6,000 shares
P1,440,000
Feb. 20 Purchase of SCAL Co. – 7,200 shares 1,800,000
Mar. 01 Sale of SCAL Co. – 2,400 shares 540,000
May 31 Receipt of FRANZ share dividend– Offsetting Credit to
retained earnings 132,000
Aug. 15 Sale of FRANZ Stocks – 4,800 shares 1,176,000
Sep. 01 Sale of FRANZ Stocks – 1,200 shares 276,000

From the Philippine Stock Exchange, the FRANZ dividends were analyzed as follows:

Nature Declared Record Payment Rate

Cash 01/02/11 01/15/11 01/31/11 P20/share
Share 05/02/11 05/15/11 05/31/11 10%
Cash 08/01/11 08/30/11 09/15/11 P30/share

At December 31, 2011, FRANZ and SCAL shares were selling at P210 and P240 per share, respectively.

QUESTIONS:

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

1. The gain or loss on sale of 2,400 SCAL shares on March 1, 2011 is

a. P540,000 gain c. P60,000 loss
b. P300,000 loss d. P60,000 gain

2. The net gain/loss on sales of FRANZ shares in 2011 is

a. P108,000 gain c. P12,000 loss
b. P142,910 gain d. P 1,090 loss

3. The total dividend income to be recognized in 2011 is

a. P198,000 c. P36,000
b. P180,000 d. P54,000

4. The carrying amount of Trading Securities as of December 31, 2011 is overstated by

a. P228,000 c. P102,000
b. P 60,000 d. P 0

5. The unrealized loss on Trading Securities to be recognized in 2011 profit or loss is

a. P52,910 c. P48,000
b. P42,000 d. P 0

PROBLEM NO. 11 Fair Value through Other Comprehensive Income

At December 31, 2014, BAGCPARS Company properly reported as noncurrent assets the following Fair Value
through Other Comprehensive Income equity securities:
Cost Market
value
EDA Corporation, 1,000 shares,
Preference share P 40,000 30,000
DJOA, Inc., 6,000 shares of ordinary share 60,000 90,000
RVFE Co., 2,000 shares of ordinary share 55,000 88,000
Totals P 155,000 208,000

During 2015, the following transactions occurred among others:

January 5 Acquired 8,000 shares of ARP Co. for P880,000 incurring additional P10,000 for brokerage and
another P10,000 for commission.

February 14 Received dividends from ARP Co. declared January 4, 2015 to the stockholders of record February 1,
2015, P16,000.

June 1 -sold 500 shares of RVFE, after a 10% stock dividend (bonus share) was received, for P35 per
share.

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CDD: Auditing Problems – Investments

October 18 Sold 2,500 shares of DJOA Inc. for P40,000. Commissions and taxes for P5,000 were paid for the sale.

November 15 Received dividends of P2 per share from DJOA Inc. declared on October 16, 2015 to the stockholders
of record October 31, 2015.

On December 31, 2015 the following are the available market values per share:

EDA Corporation – preference share P 50

DJOA, Inc. - ordinary share 15
RVFE 45
ARP Co 100

Questions:
Based on the above and the result of your audit, determine the following:
1. The correct cost of investment acquired on January 5.
a. 884,000 c. 864,000
b. 900,000 d. 884,000

2. The total dividend income during the year.

a. 7,000 c. None
b. 28,000 d. 12,000

3. The gain or loss on sale of RVFE Inc.

a. 2,500 gain c. 5,000 gain
b. 2,500 loss d. 5,000 loss

4. The gain or loss on sale of DJOA Inc.

a. 5,000 gain c. 17,500 gain
b. 5,000 loss d. 17,500 loss

5. The total adjusted balance of the investment.

a. 979,000 c. 1,001,500
b. 1,006,500 d. 997,000

PROBLEM NO. 12 Trading and FVTOCI

On December 31, 2005 ZEUS CORP’s balance sheet showed the following balances to its securities accounts:
Classification Cost Market
10, 000 shares of ABC TRADING
stock P1, 500, 000 P1,525, 000
8, 000 shares of DEF TRADING
stock 1, 100, 000 1, 056, 500
10%, GHI bonds TRADING
purchased at face
value (interest
payale-semi-annually
on January and July) 500, 000 373, 500
10, 000 shares of JKL FVTOCI
shares 1, 180, 000 1, 260, 000
20, 000 shares MNO FVTOCI
shares 980,000 1, 100, 000

During 2006 the following transactions took place:

1/1: Received the semi-annual interest from GHI.

3/1: Purchased 3,000 additional shares of ABC stocks for P459, 000 classified as trading security.
4/15: Sold 4, 000 shares of DEF stocks for P138 per share.
5/4: Sold 4, 000 shares of JKL shares for P124 per share.
7/1: Received semi-annual interest from GHI.
9/1: Purchased 400 of PQR’s 5-year, 12%, P1, 000 bonds at 93 plus accrued interest. The bonds are dated January
1, 2004. The bonds was designated as fair value through other comprehensive income securities.

The market value of the stocks and bonds on December 31, 2006 are as follows:
ABC stocks P153. 20
DEF stocks 137.00

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Driven for real excellence! AP by Darrell Joe Asuncion, CPA, MBA AP – H008
CDD: Auditing Problems – Investments
GHI bonds 82.22 (quoted Price)
JKL stocks 110.50
MNO stocks P44.00
PQR bonds 98.00 (quoted Price)

REQUIREMENTS:
1. How much is the realized gain or (loss) on the sale of DEF stocks?
a. 2, 000 b. (2, 000) c. 23, 750 d. (23,750)

2. How much is the realized gain or (loss) on sale of JKL shares?

a. (8, 000) b, 8, 000 c. (24, 000) d. 24, 000

3. How much is the unrealized holding gain to be reported in the 2006 income statement?
a. 64, 950 b. 49, 750 c. 10, 250 d. 191, 450

4. How much is the unrealized holding loss to be reported in the 2006 balance sheet?
a. 121, 000 b. 125, 000 c. 129, 000 d. 188, 000

INVESTMENT IN ASSOCIATE
7 The existence of significant influence by an investor is usually evidenced in one or more of the following ways:
(a) representation on the board of directors or equivalent governing body of the investee;
(b) participation in policy-making processes, including participation in decisions about dividends or other
distributions;
(c) material transactions between the investor and the investee;
(d) interchange of managerial personnel; or
(e) provision of essential technical information.

The Standard does not require the equity method to be applied when an associate is acquired and held with a view to
its disposal within twelve months of acquisition.

INVESTMENT IN ASSOCIATE
1 Beg. Balance Dividends received 4
or Acquisition cost Amortization of excess excldg GW 5
2 Share in the net Impairment of GW
income of associate
3 Share in revaluation Balance end
Surplus

Net investment income

2 Amortization of excess Share in the net income
excluding goodwill of associate 1
3 Impairment of goodwill
Balance end

Formula:
Acquisition cost (or purchase price) XX
Less fair value of the net asset acquired XX
Excess attributable to depreciable or amortizable
Asset or Goodwill (if negative, after reassessment of the
purchase price, gain on bus. Com) XX

PROBLEM NO. 13 Investment in Associate with Inventories, Machinery and Land - Land Was Subsequently
Sold
On January 1, 2015, Mebeilyn Co. acquired 25,000 ordinary shares out of the 100,000 outstanding ordinary shares of
Lloren Inc. for P4,000,000. Lloren’s assets and liabilities approximate their fair values except for inventories with
carrying amount of P600,000 and fair value of P400,000, machinery with carrying amount of P3,000,000 and fair
value of P1,500,000 and land with carrying amount of P1,200,000 and fair value of P1,800,000. The remaining useful
life of the machinery is 10 years. Lloren’s net assets have a book value of P12,000,000.

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Driven for real excellence! AP by Darrell Joe Asuncion, CPA, MBA AP – H008
CDD: Auditing Problems – Investments

On December 31, 2015, Lloren reported net income of P4,000,000 and declared and paid dividends of P1,000,000.

On April 30, 2016, the land of Lloren was sold at a gain of P100,000.

On December 31, 2016, Lloren reported net income of P5,000,000 and declared and paid dividends of P1,400,000.

Questions:
Based on the above date, answer the following:
1. How much is the implied goodwill from acquisition?
a. 1,275,000 c. 575,000
b. 950,000 d. 1,000,000

2. How much is the net share in the profit or loss of the associate (investment income) in 2015?
a. 937,500 c. 1,087,500
b. 1,000,000 d. 950,000

3. How much is the carrying amount of the investment as of December 31, 2015?
a. 4,687,500 c. 4,837,500
b. 5,087,500 d. 4,700,000

4. How much is the net share in the profit or loss of the associate (investment income) in 2016?
a. 1,250,000 c. 1,162,500
b. 1,137,500 d. 1,112,500

5. How much is the carrying amount of the investment as of December 31, 2016?
a. 6,125,000 c. 5,775,000
b. 6,150,000 d. 6,100,000

ASSOCIATE HAVING OUTSTANDING CUMULATIVE PREFERENCE SHARES

If an associate has outstanding cumulative preference shares that are held by parties other than the investor and
classified as equity, the investor computes its share of profits or losses after adjusting for the dividends on such
shares, whether or not the dividends have been declared.
COMPUTATION OF THE SHARE IN THE NET INCOME
Net income of the associate XX
Less *TOTAL Preference dividend XX
Net income to ordinary share XX
X (Percentage of ownership-Ordinary shares) %
Share in net income of the associate XX

The total preference dividend is deducted from the net income if:
Cumulative preference share Deduct the preference dividends whether or not such dividends are declared.
Noncumulative preference share Deduct the preference dividends only when declared.

PROBLEM NO. 14
On January 1, 2009, NCPAR Company acquired 20% of the outstanding ordinary shares of BRAYDEN Company for
P4,000,000. This investment gave NCPAR the ability to exercise significant influence over BRAYDEN. The book value
of the acquired shares was P3,000,000. The excess of cost over book value was attributed to a depreciable assets
which was undervalued on BRAYDEN’ statement of financial position and which had a remaining useful life of ten
years.
For the year ended December 31, 2009, BRAYDEN’ share capital outstanding is as follows:
10% cumulative preference share capital 2,500,000
Ordinary share capital 10,000,000

BRAYDEN reported net income P1,500,000 for the year ended December 31, 2009.

CASE NO. 1- Assuming the cumulative preference share is treated as equity by BRAYDEN and that BRAYDEN declared
dividends of P300,000 on the preference shares, answer the following:
1. What amount should NCPAR record as investment income for the year ended December 31, 2009?
2. What amount should NCPAR record as investment in associate for the year ended December 31, 2009?

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Driven for real excellence! AP by Darrell Joe Asuncion, CPA, MBA AP – H008
CDD: Auditing Problems – Investments

CASE NO. 2- Assume instead that the preference shares are non-cumulative preference share treated as equity by
BRAYDEN and that BRAYDEN declared dividends of P300,000 on the preference shares, answer the following:
1. What amount should NCPAR record as investment income for the year ended December 31, 2009?
2. What amount should NCPAR record as investment in associate for the year ended December 31, 2009?

CASE NO. 3- Assuming the cumulative preference share is treated as Financial liability by BRAYDEN, answer the
following:
1. What amount should NCPAR record as investment income for the year ended December 31, 2009?
2. What amount should NCPAR record as investment in associate for the year ended December 31, 2009?

PROBLEM NO. 15 CHANGE FROM COST TO EQUITY METHOD

On January 1, 2013, David Company bought 10% of the outstanding ordinary shares of Jean Construction Company for
P3 million. Their book value was P8 million and the difference was attributable to the fair value of Jean’s buildings
exceeding book value. Jean’s net income for the year ended December 31, 2013, was P10 million. During 2013, Jean
declared and paid cash dividends of P2 million. The buildings have a remaining life of 10 years. The investment in Jean
is to be held as Fair Value through other comprehensive income.

Also, Jean’s net income for the year ended December 31, 2014 was P12 million and Jean declared and paid cash
dividends of P2.5 million.

The fair value of David’s investment in Jean securities is as follows: December 31, 2013, P3,200,000; December 31,
2014, P3,100,000; and December 31, 2015, P13 million.

On January 2, 2015, David purchased an additional 20% of Jean’s stock for P5,600,000 cash when the carrying amount
of Jean’s net assets was P25,000,000. The excess was attributable to building having a remaining life of 8 years.

Jean’s net income for the year ended December 31, 2015 was P15 million and Jean declared and paid cash dividends
of P3 million.

Required:
A. Based on the above and the result of your audit, determine the following:
1. The unrealized gain or loss to be presented in the other comprehensive income as of December 31, 2013.
2. The income from investment in Jean Company to be recognized in 2014 profit or loss is:
3. The adjustment to retained earnings as of January 2, 2015 as a result of the acquisition of the additional 30%
interest in Jean Company is:
4. The income from investment in Jean Company to be recognized in 2015 profit or loss is:
5. The carrying amount of the investment in Jean Company as of December 31, 2015 is:

PROBLEM NO. 16 DISCOUNTINUANCE OF EQUITY METHOD-CHANGE FROM EQUITY

On January 1, 2014, James Company bought 200,000 ordinary shares out of the 1,000,000 outstanding ordinary
shares of Lyn Construction Company for P30 million. Their book value was P130 million and the difference was
attributable to the fair value of Lyn’s buildings and its land exceeding book value, each accounting for one-half of the
difference. Lyn’s net income for the year ended December 31, 2014 was P150 million. During 2014, Lyn declared and
paid cash dividends of P30 million. The buildings have a remaining life of 10 years.

On January 2, 2015, James sold half of its investment at P28 million and reclassified its remaining investment to Fair
Value through other comprehensive income. The fair value of the shares this date amounted to P285 per share. Lyn’s
net income for the year ended December 31, 2015, was P160 million. During 2015, Lyn declared and paid cash
dividends of P28 million. On December 31, 2015, the fair value of the shares amounted to P290 per share.

Required:
A. Compute for the following:
1) What is the investment balance on December 31, 2014?
2) What is the gain on sale of 100,000 shares on January 2, 2015?
3) What is the total amount that should be recognized in profit or loss on January 2, 2015?
4) What is the unrealized gain to be recognized in the December 31, 2015 statement of financial position?

ADJUSTMENT OF INVESTEE’S OPERATIONS

Upstream Transactions
Profits and losses resulting from ‘upstream’ and ‘downstream’ transactions between an investor (including its
consolidated subsidiaries) and an associate are recognized in the investor’s financial statements only to the extent of
unrelated investors’ interests in the associate. ‘Upstream’ transactions are, for example, sales of assets from an
associate to the investor.

Downstream Transactions
‘Downstream’ transactions are, for example, sales of assets from the investor to an associate. The investor’s share in
the associate’s profits and losses resulting from these transactions is eliminated.

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Driven for real excellence! AP by Darrell Joe Asuncion, CPA, MBA AP – H008
CDD: Auditing Problems – Investments

When downstream transactions provide evidence of a reduction in the net realizable value of the assets to be sold or
contributed, or of an impairment loss of those assets, those losses shall be recognized in full by the investor. When
upstream transactions provide evidence of a reduction in the net realizable value of the assets to be purchased or of
an impairment loss of those assets, the investor shall recognize its share in those losses.

The share in the profit or loss of an associate is recognized only to the extent of unrelated investors’ interest in the
associate. If the transaction is:
• Downstream sale - eliminate the entire unrealized profit. (i.e. 100%)
• Upstream sale - eliminate the investor’s share in unrealized profit. (percentage of ownership)

Basic Formula:
Net income x percentage of ownership XX
Less: Unrealized profit on upstream sale x percentage of ownership ( XX )
Add: Realized profit on upstream sale x percentage of ownership XX
Less: Unrealized profit on downstream sale ( XX )
Add: Realized profit on downstream sale XX
Share in the net income XX

PROBLEM NO. 17
On January 1, 2015, Myrah Company acquired 30% of the ordinary shares of an associate for P4,000,000. On this date,
all the identifiable assets and liabilities of the associate were recorded at fair value. An analysis of the acquisition
showed that goodwill of P200,000 was acquired.

The net income and dividend of the associate for 2015 and 2016 were as follows:

2015 2016
Net income 2,000,000 3,000,000
Dividend paid 800,000 1,200,000

On January 3, 2015, Myrah Company sold an equipment costing P600,000 to the associate Company for P800,000. The
equipment has a remaining life of 5 years.

In December 2015, the associate sold inventory to Myrah Company for P700,000. The cost of the inventory was
P600,000. This inventory remained unsold by Myrah Company on December 31, 2015. However, it was sold by Myrah
Company in 2016.

In December 2016, the associate sold inventory to Myrah Company for P550,000. The cost of the inventory was
P400,000. This inventory remained unsold by Myrah Company on December 31, 2016.

Questions:
Based on the above date, determine the following:
1. Net share in the net income (or loss) of the associate in 2015
a. 600,000 c. 410,000
b. 440,000 d. 760,000

2. Net share in the net income (or loss) of the associate in 2016
a. 900,000 c. 860,000
b. 865,000 d. 925,000

3. Carrying amount of the investment in associate on December 31, 2015

a. 4,410,000 c. 4,440,000
b. 4,600,000 d. 4,760,000

4. Carrying amount of the investment in associate on December 31, 2016

a. 5,310,000 c. 5,335,000
b. 5,500,000 d. 5,635,000

5. Assuming the company is a small/medium entity and uses the equity method, the carrying amount of investment
on December 31, 2016 is
a. 4,310,000 c. 4,695,000
b. 4,500,000 d. 4,635,000

PROBLEM NO. 18

The following two subsidiary accounts reflect the trading securities of Jordano Company for the year 2005:

LOYAL COMPANY
Date Transactions Shares Ref. Debit Credit
Jan. 16 Purchase 20,000 CD P1,900,000

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Driven for real excellence! AP by Darrell Joe Asuncion, CPA, MBA AP – H008
CDD: Auditing Problems – Investments
31 Raised to market value, offset
credit to retained earnings GJ 100,000
Mar. 30 Sale at P150 10,000 CR P1,500,000
June 10 Stock dividend at par 10,000 GJ 1,000,000
July 29 Sale at P110 10,000 CR . 1,100,000
Totals P3,000,000 P 2,600,000

FAITHFUL CORP.
Date Transactions Shares Ref. Debit Credit
Sep. 05 Purchase 20,000 CD P1,000,000
28 Cash dividends to stockholders of
record Sept. 15, declared Aug. 15 P 50,000
CR
Oct. 01 Purchase 50,000 CD 2,500,000
05 Sale at P65 20,000 CR 1,000,000
Nov.30 Cash collected for sale made on
Nov. 10, after a Nov. 1 declaration
of P5 cash dividend per share to
stockholders on record as of
December 1
20,000 CR 3,300,000
Dec.15 Cash dividend received CR . 150,000
Totals P3,500,000 P4,500,000

On January 2, 2005, Jordano Company purchased 39,000 shares of Trustworthy Co.’s 200,000 shares of outstanding
common stock for P1,170,000. On that date, the carrying amount of the acquired shares on Trustworthy Co.’s books
was P810,000. Jordano attributed the excess of cost over carrying amount to goodwill.

During 2005, Jordano’s president gained a seat on Trustworthy’s board of directors. Trustworthy reported earnings
of P800,000 for the year ended December 31, 2005, and declared and paid cash dividends of P200,000 during 2005.
On December 31, 2005, Trustworthy’s common stock was trading at P30 per share.

QUESTIONS:

1. The gain on sale of 10,000 shares of Loyal Company on March 30 is

a. P500,000 b. P1,500,000 c. P550,000 d. None
2. The gain on sale of 10,000 shares of Loyal Company on July 29 is
a. P625,000 b. P337,500 c. P525,000 d. P150,000
3. The correct acquisition cost of 20,000 shares of Faithful Corp. acquired on September 5 is
a. P3,500,000 b. P950,000 c. P1,000,000 d. P3,450,000
4. The gain on sale of 20,000 shares of Faithful Corp. October 5 is
a. P350,000 b. P300,000 c. P1,028,500 d. P314,300
5. The gain on sale of 20,000 shares of Faithful Corp. on November 10 is
a. P1,000,000 b. P2,400,000 c. P2,300,000 d. P2,200,000
6. The balance of the Company’s investment in Loyal Company before mark-to-market on December 31, 2005 is
a. P475,000 b. P500,000 c. P1,475,000 d. P525,000
7. The adjusted balance of the Company’s investment in Faithful Corp. before mark-to-market on December 31,
2005 is
a. P1,500,000 b. P1,350,000 c. P1,200,000 d. P1,000,000
8. The income from investment in common stock of Trustworthy Company to be reported on the income
statement for the year ended December 31, 2005 is
a. P156,000 b. P159,000 c. P120,000 d. P39,000
9. The adjusted balance of investment in Trustworthy Company at December 31, 2003 is
a. P1,326,000 b. P1,170,000 c. P1,287,000 d. P1,251,000

SUGGESTED ANSWERS: C, A, B, A, D, A, A, A, C

END OF HANDOUTS!

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Driven for real excellence! AP by Darrell Joe Asuncion, CPA, MBA AP – H008