Auditing Problemswatitiw1. Draft income statement of Raffles
Inc. is as follows:
SalesP700,000
Cost of sales
Opening inventory60,000
Purchases430,000
Closing inventory90,000400,000
Gross profit300,000
Expenses200,000
ProfitP100,000
How much is the correct profit after the following
adjustments?(1) Closing inventory includes goods costing P20,000
which are expected to realize at P19,000.(2) A customer has taken
legal action for damages of P50,000 against Raffles. The lawyer of
Raffles has advised the customer that he has a 25% chance of
success.(3) After the balance sheet date, a vehicle was damaged in
an accident. The carrying amount of the vehicle was P6,000. It was
not insured.(4) Raffles has sued one of its competitors for
P60,000. The chance of Raffles winning the case is 75%. The outcome
will be known in three months.A.P159,000
B.P103,000
C.P99,000
D.P49,000
Solution: C is correctUnadjusted profitP100,000
(1) Write down of inventory to its NRV (20,000
19,000)(1,000)
(2) Loss not probable no adjustment-
(3) Non-adjusting event after the balance sheet date - no
adjustment-
(4) Gain not virtuallycertain no adjustment-
Adjusted profitP99,000
2. Zod Company reports the following information as of December
31:
Sales revenueP800,000
Cost of goods sold600,000
Operating expenses90,000
Unrealized gain on available-for-sale securities30,000
How much should the company report as total comprehensive
income?
A.P80,000
B.P110,000
C.P140,000
D.P200,000
Solution: C is correctSales revenueP800,000
Less: Cost of goods sold600,000
Less: Operating expenses90,000
Amount taken to P&LP110,000
Amount taken to OCI30,000
Total comprehensive incomeP140,000
3. You are assigned to the audit of Canon Company who spent
P12,000,000 during the current year developing its new software
package. Of this amount, P4,000,000 was spent before it was at the
application development stage and the package was only to be used
internally. The package was completed during the year and is
expected to have a four year useful life. Canon Company has a
policy of taking a full-year's amortization in the first year.
After the development stage, P50,000 was spent on training
employees to use the program. What amount should Canon Company
report as an expense for the current year?
A.P2,012,500
B.P2,050,000
C.P6,012,500
D.P6,050,000
Solution: D is correctAmount spent before the development
stageP4,000,000
Amount spent on training employees 50,000
Amortization of the software package(12M 4M) / 4
years2,000,000
Total expense to be recognizedP6,050,000
4. You were assigned to audit the factory accounts of Ministops
Corporation for the year ended December 31, 2012. The following
data were gathered: Manufacturing cost totalled P900,000. Cost of
goods manufactured was P800,000 of which factory overhead was 75%
of direct labor. Overhead was 25% of total manufacturing cost.
Beginning work-in process inventory was 60% of ending
work-in-process inventory. Manufacturing costs for the year ended
December 31, 2012 submitted to you by the factory accountant were
as follows:
Raw materials usedP400,000
Direct labor275,000
Factory overhead225,000
TotalP900,000
Assume cost percentage relationships as stated were correct.
Which of the following adjusting journal entries is correct?
A.Raw materials usedP25,000Direct laborP25,000B.Direct
laborP25,000Raw materials usedP25,000C.Raw materials
usedP50,000Direct laborP50,000D.Direct laborP50,000Raw materials
usedP50,000
Solution: B is correctFactory overhead (75% of direct
labor)P225,000
Divided by 75%75%
Direct labor, per recomputation300,000
Direct labor, unadjusted 275,000
Adjustment to direct laborP25,000
5. On June 1, 2008, Psy Corporation purchased as a long term
investment 6,000 of the P1,000 face value, 8% bonds of Lyre
Corporation. Psy Corporation has the positive intention and ability
to hold these bonds to maturity. The bonds were purchased to yield
10% interest. Interest is payable semi-annually on December 1 and
June 1. The bonds mature on June 1, 2014. On November 1, 2009, Psy
Corporation sold the bonds for a total consideration of P5,887,500.
Based on the above and the result of your audit, determine the
following: (Round off present value factors to four decimal places)
- the purchase price of the bonds on June 1, 2008 is
A.P5,467,992
B.P5,467,992
C.P5,545,104
D.P5,436,894
Solution: A is correct
PV of the principal(0.5568 x 6,000,000)P3,340,800
PV of the interest(8.8633 x 6,000,000 x 4%)2,127,192
P5,467,992
6. The Tiger Corporation included the following in its
unadjusted trial balance as of December 31, 2012:
Inventory, 12/31/11P19,450,000
Purchases127,850,000
Additional information: The inventory at December 31, 2012 was
counted at a cost of P8.5 million. This includes P500,000 of slow
moving inventory that is expected to be sold for P300,000. Sales
include P8 million for goods sold in December 2012 for cash to Beer
Finance Company. The cost of these goods was P6 million. Beer
Finance Company has the option to require Tiger to repurchase these
goods within one month of year-end at their original selling price
plus a facilitating fee of P250,000. The Companys accounting policy
is to present cost of writing down inventory to NRV as part of cost
of sales.The cost of sales for the year ended December 31, 2012
isA.P138,800,000
B.P133,000,000
C.P132,800,000
D.P139.000.000
Solution: B is correctAmount in thousands:Inventory,
beginningP19,450
Add: Purchases127,850
Less: Inventory, ending8,500
Cost of sales, unadjusted138,800
Add: to adjust to net realizable value the items in ending
inventory200
Less: Item sold under repurchase agreement6,000
Cost of sales, adjustedP133,000
7. Inventory per count on December 31, 2012 as reported by WS
Company was at P560,000. The amount does not include the following
items:A. Merchandise costing P27,500 received on January 3, 2013,
and purchase invoice recorded on January 5, 2013. Shipment was made
on December 25, 2012,terms FOB destination.B. Merchandise costing
P20,000 was physically segregated in the warehouse and was set
aside for shipmentto a customer (shipment scheduled on January 2,
2013). This will be invoiced to the customer by then at P28,000.C.
Merchandise received on January 7, 2013, costing P17,000 was
entered in the purchases journal on January 8, 2013. Invoice
shipment was made FOB shipping point on December 30, 2012.
What is the adjusted balance of inventories to be presented in
the 2012 statement of financial position?A.P597,000
B.P580,000
C.P578,000
D.P587,500
Solution: A is correctUnadjusted inventory balanceP560,000
Item (a) Goods received January 2013, under FOB Destination,
thus item is correctly excluded-
Item (b) Goods still in warehouse but were not included in the
count20,000
Item (c) Goods received January 2013, under FOB shipping point.
Items shipped December 30, 201217,000
Adjusted inventory balanceP597,000
8. Bohol Company leased office premises to Jill Company for a
5-year term starting January 2, 2013. Under the terms of the lease,
rent for the first year is P200,000 and rent for years 2 through 5
is P300,000 annually. As an inducement to enter the lease, Bohol
Company waives the first six month payments. Jill Company likewise
paid a P70,000 security deposit of which 80% is refundable at the
end of the lease term. Furthermore, contingent rent equal to 2% of
sales in excess of P12,000,000 shall be paid by Jill Company. Bohol
Company incurred initial direct cost of P40,000 while JL Company
paid P30,000 in costs in relation to the lease. In 2013, Jill
Company reported sales of P13,000,000.
Rental expense to be included in Jill Companys 2013 income
statement isA.288,800
B.268,800
C.302,200
D.315,000
Solution: A is correctTotal rental payments for five
years(P200,000/2) + (P300,000 x 4)P1,300,000
Divided by total years5 years
Annual rental expense (fixed)P260,000
Contingent rent [(P13M P12M) x 2%]20,000
Direct cost incurred(30,000 / 5)6,000
Non-refundable portion of security deposit(P70,000 x 20%) /
52,800
Total rental expenseP288,800
The following information applies to the next two
questions:Listed below are four interbank cash transfers, indicated
by the numbers 1, 2, 3, and 4, of a client for late December 2010
and early January 2011: Bank Account OneBank Account TwoDisbursing
DateReceiving Date(Month/Day)(Month/Day)Per BankPer BooksPer
BankPer
Books1.12/3112/3012/3112/302.1/212/3012/3112/313.1/312/311/21/24.1/312/311/212/31
9.
Based on the schedule of interbank transfers above, which of the
cash transfers indicates an error in cash cutoff at December 31,
2010?a.1b.2c.3d.4
Answer: C
10.
Based on the schedule of interbank transfers above, which of the
cash transfers would appear as a deposit in transit on the December
31, 2010 bank reconciliation?a.1b.2c.3d.4
Answer: D
Auditing Theory
1. Which of the following are the three principal methods in
sample selection are specifically identified in PSA 530?A.
Statistical sampling, attribute sampling and haphazard samplingB.
Random number selection, systematic selection and haphazard
selectionC. Sequential sampling, discovery sampling and statistical
samplingD. Sequential sampling, discovery sampling and random
number selection
Answer: B(PSA 530, Audit Sampling)
2. Which of the following is an appropriate consideration in
auditors selection of sample size?A. The auditor may select a
voided or cancelled document in a sample. If the document has been
properly voided, treat the item as deviation.B. If the auditor
encounters missing documents and he is unable to determine whether
control has been properly performed, replace the document with
another sample item.C. The auditor may select a voided or cancelled
document in a sample. If the document has been properly voided,
replace the document with another sample itemD. If the auditor
encounters missing documents and he is unable to determine whether
control has been properly performed, treat the item as deviation
and replace the document with another sample item.
Answer: C(PSA 530, Audit Sampling)
The auditor may select a voided or cancelled document in a
sample. If the document has been properly voided, the document must
be replaced with another sample item. If the auditor encounters
missing documents and he is unable to determine whether control has
been properly performed, the auditor must treat the item as
deviation.
3. Fraudulent financial reporting involves intentional
misstatements or omissions of amount or disclosures in the
financial statements to deceive financial statement users. Which of
the following acts appropriately involves fraudulent financial
statements?
I. Manipulations, falsification or alteration of records or
documentsII. Lapping of accounts receivableIII. Recording of
transactions without substanceIV. Stealing entitys assets such as
cash, marketable securities and inventoryV. Intentional application
of accounting policies
A. I and IIB. I, II , III and IVC. I, III and VD. All of the
above
Answer: C(PSA 240, Auditors Responsibility to Consider Fraud in
an Audit of Financial Statements)
Fraudulent financial reporting involves intentional
misstatements or omissions of amount or disclosures in the
financial statements to deceive financial statement users. This may
involve:I. Manipulations, falsification or alteration of records or
documents.II. Misrepresentation in or intentional omission of the
effects of transactions from records or documents.III. Recording of
transactions without substance andIV. Intentional application of
accounting policies
4. Which of the following is not true with reference to the Code
of Professional Ethics for CPAs?A. Acting as advocate of an audit
client in resolution of a dispute or litigation that involves
amounts material to the financial statements of the audit client
impairs CPAs independence.B. A firm or network firm should not
provide accounting and bookkeeping services for an audit client
that is not a listed entity.C. Fees are not to be regarded as
contingent if these are fixed by a courtD. A professional
accountant in public practice may enter into an arrangement for the
purchase of the whole or part of an accounting practice requiring
payments to individuals formerly engaged in the practice.
Answer: B(Code of Professional Ethics for CPAs)
According to Code of Professional Ethics for CPAs, a firm or
network firm should not provide accounting and bookkeeping services
for an audit client that is a listed entity. The provision of such
services may impair CPAs independence, or at least give the
appearance of impairing independence.
5. Which of the following acts is prohibited by the Code of
Professional Ethics for CPAs?
A. The use of a firm name which includes the name of a retired
partnerB. An announcement in a newspaper of the opening of a public
accounting officeC. Engaging in civic activities during business
hoursD. Accepting an engagement or employment which one cannot
reasonable expect to compete or discharge with professional
competence
Answer: D(Code of Professional Ethics for CPAs)
6. When an independent auditors examination of financial
statements discloses special circumstances that make the auditor
suspects that fraud may exist, the auditors initial course of
action should be to
A. Recommend that the client pursue the suspected fraud to a
conclusion that is agreeable to the auditorB. Extend normal audit
procedures in an attempt to detect the full extent of the suspected
fraudC. Reach an understanding with the proper client
representative as to whether the auditor or the client is to make
the investigation necessary to determine if a fraud has in fact
occurredD. Determine whether the fraud, if in fact it does exist,
might be of such a magnitude as to affect the auditors report on
the financial statements
Answer: D(PSA 250, Consideration of Laws and Regulations in an
Audit of Financial Statements, Section 58)
7. When an independent auditor decides that the work performed
by internal auditors may have a bearing on the nature, timing and
extent of planned audit procedures, the independent auditor should
evaluate the objectivity of the internal auditors. Relative to
objectivity, the independent auditor should
A. Consider the organizational level to which internal auditors
reportB. Review the quality control program in effect for the
internal audit staffC. Examine the quality of the internal audit
reportsD. Consider the qualifications of the internal audit
staff
Answer: A(PSA 610, Using the Work of Internal Auditors)
8. During an assessment of the risk associated with sales
contracts and related commissions, which of the following factors
would most likely result in an expansion of the engagement scope?
A. An increase in product sales, along with an increase in
commissionsB. An increase in sales returns, along with an increase
in commissionsC. A decrease in sales commissions, along with a
decrease in product salesD. A decrease in sales returns, along with
an increase in product sales
Answer: B(Gleims Certified Internal Auditor Reviewer)
Trends described in A, C and D are compatible while trend in B
are incompatible and may indicate inflated sales figures.
9. Which of the following explanations suggests the least amount
of relative risk stemming from a failure to compare a purchase
order to an approved price list?A. A temporary employee processed
the purchase order.B. The comparison is not required by company
policy.C. The vendor is one used often by the company.D. The
director of the purchasing department approved the purchase
order.
Answer: A(Sawyers Certified Internal Auditor Reviewer)
A is correct. The relative risk of loss to the company would be
lower if a temporary employee were responsible for the error. This
suggests an isolated incident, as the employee will not be able to
repeat the error once he or she has left the purchasing department.
However, the error should still be reported to management.B is
incorrect. If employees are not required to consult an approved
price list, the company risks buying at too great a price.C is
incorrect. Even if the company regularly buys from this vendor,
there is no assurance that the price is reasonable unless the
purchase order is compared to the approved price list.D is
incorrect. The director should have required the purchase order to
be compared to the approved price list before approving it.
Otherwise, the purchase price may exceed the approved price.
10. Which of the following fraudulent entries is most likely to
be made to conceal the theft of an asset?A. Debit expenses, and
credit the assetB. Debit the asset, and credit another asset
accountC. Debit revenue, and credit the assetD. Debit another asset
account, and credit the asset
Answer: A(Sawyers Certified Internal Auditor Reviewer)
A is correct. Most fraud perpetrators would attempt to conceal
their theft by charging it against an expense account.B is
incorrect. Debiting the stolen asset account would be going in the
wrong direction to conceal an asset theft.C is incorrect. An entry
decreasing revenue would be unusual and would stand out.D is
incorrect. This entry would not permanently conceal the fraud. It
would simply shift the unreconcilable balance to another asset
account.
11. What computer-assisted audit technique would an auditor use
to identify a fictitious or terminated employee?A. Parallel
simulation of payroll calculations.B. Exception testing for payroll
deductions.C. Recalculations of net pay.D. Tagging and tracing of
payroll tax-rate changes.
Solution: Ba) Incorrect. In a parallel simulation, data that
were processed by the engagement clients system are reprocessed
through the auditors program to determine if the output obtained
matches the output generated by the clients system. This technique
might identify problems with the clients processing but would not
identify a fictitious or terminated employee.b) Correct. This type
of computer-assisted audit technique (CAAT) program can identify
employees who have no deductions. This is important because
fictitious or terminated employees will generally not have any
deductions.c) Incorrect. A CAAT program can recalculate amounts
such as gross pay, net pay, taxes and other deductions, and
accumulated or used leave times. These recalculations can help
determine if the payroll program is operating correctly or if
employee files have been altered, but would not identify a
fictitious or terminated employee.d) Incorrect. In this type of
CAAT program, certain actual transactions are tagged, and as they
proceed through the system, a data file is created that traces the
processing through the system and permits an auditor to
subsequently review that processing. This would not, however,
identify a fictitious or terminated employee.
12. A chief audit executive (CAE) suspects that several
employees have used desktop computers for personal gain. In
conducting an investigation, the primary reason that the CAE chose
to engage a forensic information systems auditor rather than using
the organizations information systems auditor is that a forensic
information systems auditor would possess:A. Knowledge of the
computing system that would enable a more comprehensive assessment
of the computer use and abuse.B. Knowledge of what constitutes
evidence acceptable in a court of law.C. Superior analytical skills
that would facilitate the identification of computer abuse.D.
Superior documentation and organization skills that would
facilitate in the presentation of findings to senior management and
the board.
Solution: Ba) Incorrect. The organizations information systems
auditor would probably have more knowledge of the organizations
computing systems.b) Correct. The distinguishing characteristic of
forensic auditing is the knowledge needed to testify as an expert
witness in a court of law. Although a forensic auditor may possess
the other attributes listed, the organizations information systems
auditor may also possess these skills or knowledge elements.c)
Incorrect. A forensic auditor would not necessarily have analytical
or organizational skills that are superior to those of the
organizations auditor.d) Incorrect. See answer c.
13. An audit committee is concerned that management is not
addressing all internal audit observations and recommendations.
What should the audit committee do to address this situation?A.
Require managers to provide detailed action plans with specific
dates for addressing audit observations and recommendations.B.
Require all managers to confirm when they have taken action.C.
Require the chief executive officer to report why action has not
been taken.D. Require the chief audit executive to establish
procedures to monitor progress.
Solution: Da) Incorrect. Management are responsible for ensuring
action on all internal audit observations and recommendations, but
some actions may take time to complete and it is not practical to
expect that all will be resolved when an audit committee meets.b)
Incorrect. See answer a.c) Incorrect. See answer a.d) Correct. The
chief audit executive is responsible for establishing appropriate
procedures for monitoring the progress by management on all
internal audit observations and recommendations. This
responsibility should be written into its charter by the audit
committee, and progress should be reported at each audit committee
meeting.
14. As part of a manufacturing companys environmental, health,
and safety (EHS) self-inspection program, inspections are conducted
by a member of the EHS staff and the operational manager for a
given work area or building. If a deficiency cannot be immediately
corrected, the EHS staff member enters it into a tracking database
that is accessible to all departments via a local area network. The
EHS manager uses the database to provide senior management with
quarterly activity reports regarding corrective action. During
review of the self-inspection program, an auditor notes that the
operational manager enters the closure information and affirms that
corrective action is complete. What change in the control system
would compensate for this potential conflict of interest?A. No
additional control is needed because the quarterly report is
reviewed by senior management, providing adequate oversight in this
situation.B. No additional control is needed because those
implementing a corrective action are in the best position to
evaluate the adequacy and completion of that action.C. After
closure is entered into the system, review by the EHS staff member
of the original inspection team should be required in order to
verify closure.D. The EHS department secretary should be
responsible for entering all information in the tracking system
based on memos from the operational manager.
Solution: Ca) Incorrect. Although senior management can use the
report to question why certain corrective actions may be behind
schedule, they have no way of knowing whether the corrective
actions shown as complete were actually completed.b) Incorrect.
While the operational managers may in fact be the most
knowledgeable about the corrective action, independent verification
is preferable.c) Correct. If there is a step in the process at
which someone independent of the area being inspected can evaluate
the adequacy and completeness of corrective action, the potential
for closure fraud is minimized.d) Incorrect. There is nothing
inappropriate about the environmental, health, and safety staff
entering the initial inspection results. Having the secretary enter
closure data does not improve controls since there is still no
independent review. It is also less efficient and timely than
having the data entered directly in the field.
15. An audit of an organizations claims department determined
that a large number of duplicate payments had been issued due to
problems in the claims processing system. During the exit
conference, the vice president of the claims department informed
the auditors that attempts to recover the duplicate payments would
be initiated immediately and that the claims processing system
would be enhanced within six months to correct the problems. Based
on this response, the chief audit executive should:A. Adjust the
scope of the next regularly scheduled audit of the claims
department to assess controls within the claims processing
system.B. Monitor the status of corrective action and schedule a
follow-up engagement when appropriate.C. Schedule a follow-up
engagement within six months to assess the status of corrective
action.D. Discuss the findings with the audit committee and ask the
committee to determine the appropriate follow-up action.
Solution: Ba) Incorrect. Because the finding is significant, the
internal audit activity should not wait until the next regularly
scheduled audit to assess the status of corrective action.b)
Correct. The internal audit activity should monitor the status of
the corrective action. A follow-up engagement should be scheduled
when changes to the claims processing system have been sufficiently
completed to allow for testing of adequacy and effectiveness.c)
Incorrect. Although management indicated that the corrections
should be completed within six months, this may not be the case. As
a result, the internal audit activity should monitor the status of
corrective action and schedule a follow-up engagement when it is
appropriate.d) Incorrect. Although the findings should be discussed
with the audit committee because of their significance, the scope
and timing of a follow-up engagement should be determined by the
chief audit executive based on available information.
16. An organization uses electronic data interchange and on-line
systems rather than paper-based documents for purchase orders,
receiving reports, and invoices. Which of the following audit
procedures would an auditor use to determine if invoices are paid
only for goods received and at approved prices?
A. Select a statistical sample of major vendors and trace the
amounts paid to specific invoices.B. Use generalized audit software
to select a sample of payments and match purchase orders, invoices,
and receiving reports stored on the computer using a common
reference.C. Select a monetary-unit sample of accounts payable and
confirm the amounts directly with the vendors.D. Use generalized
audit software to identify all receipts for a particular day and
trace the receiving reports to checks issued.
Solution: BA. Incorrect. This procedure only provides data on
whether payments agree with invoices. It does not provide data on
whether the invoiced amounts are correct.B. Correct. This would
help the auditor determine that all three pieces of data were most
likely matched before payment.C. Incorrect. As with answer a, this
only provides data on whether payments agree with invoices. It does
not provide data on whether the goods were actually received.D.
Incorrect. This provides data only on one day. While it matches
items received with those paid, it does not provide data on whether
the billings were correct.
17. A sales department has been giving away expensive items in
conjunction with new product sales to stimulate demand. The
promotion seems successful, but management believes the cost may be
too high and has asked for a review by the internal audit activity.
Which of the following procedures would be the least useful to
determine the effectiveness of the promotion?A. Comparing product
sales during the promotion period with sales during a similar
non-promotion period.B. Comparing the unit cost of the products
sold before and during the promotion period.C. Performing an
analysis of marginal revenue and marginal cost for the promotion
period, compared to the period before the promotion.D. Performing a
review of the sales departments benchmarks used to determine the
success of a promotion.
Solution: Ba) Incorrect. This comparison would help highlight
the effectiveness of the promotion in increasing sales.b) Correct.
There is no indication that cost of the products sold has changed.
The challenge is to address the effectiveness of the promotion.c)
Incorrect. This is the key analysis as it would show the extent of
additional revenue versus cost.d) Incorrect. This would be helpful
because the sales department may have useful information on new
customers and repeat purchases.
18. Which of the following observations by an auditor is most
likely to indicate the existence of control weaknesses over
safeguarding of assets?
I. A service department's location is not well suited to allow
adequate service to other units.II. Employees hired for sensitive
positions are not subjected to background checks.III. Managers do
not have access to reports that profile overall performance in
relation to other benchmarked organizations.IV. Management has not
taken corrective action to resolve past engagement observations
related to inventory controls.
a) I and II only.b) I and IV only.c) II and III only.d) II and
IV only.
Solution: D (II and IV only)I. Incorrect. This is a symptom of
weak controls for achieving organizational goals and objectives,
but not for safeguarding of assets.II. Correct. This is a symptom
of weak controls for safeguarding of assets.III. Incorrect. This is
a symptom of weak controls for achieving organizational goals and
objectives, but not for safeguarding of assets.IV. Correct.
Management's failure to take corrective action on past engagement
observations, which related to safeguarding of assets, is a
weakness related to safeguarding of assets.
19. The use of an analytical review to verify the correctness of
various operating expenses would not be a preferred approach if:A.
An auditor notes strong indicators of a specific fraud involving
these accounts.B. Operations are relatively stable and have not
changed much over the past year.C. An auditor would like to
identify large, unusual, or non-recurring transactions during the
year.D. Operating expenses vary in relation to other operating
expenses, but not in relation to revenue.
Solution: Aa) Correct. If the auditor already suspects fraud, a
more directed audit approach would be appropriate.b) Incorrect.
Relatively stable operating data is a good scenario for using
analytical review.c) Incorrect. Analytical review would be useful
in identifying whether large, non-recurring, or unusual
transactions occurred.d) Incorrect. Analytical review only needs to
have accounts related to other accounts or other independent data.
It does not require that they be related to revenue.
20. As part of a preliminary survey of the purchasing function,
an auditor read the department's policies and procedures manual.
The auditor concluded that the manual described the processing
steps well and contained an appropriate internal control design.
The next engagement objective was to determine the operating
effectiveness of internal controls. Which procedure would be most
appropriate in meeting this objective?
a) Prepare a flowchart.b) Prepare a system narrative.c) Perform
a test of controls.d) Perform a substantive test.
Solution: Ca) Incorrect. Flowcharts are most appropriate for
studying internal control design. The audit objective is whether
the controls are in place and effective, which indicates the need
for a test of controls.b) Incorrect. System narratives are most
appropriate for studying internal control design. The audit
objective is whether the controls are in place and effective, which
indicates the need for a test of controls.c) Correct. Tests of
controls, also known as compliance tests, help an auditor determine
whether controls are being followed and are effective. For
instance, a policy may require that all large transactions be
approved by a manager. As a test of controls, the auditor may
sample large transactions and review whether manager approval was
obtained and whether the proposed transaction meets all the
criteria that the manager was supposed to verify.d) Incorrect.
Substantive tests are tests to determine whether an objective has
been achieved and do not necessarily test internal controls.
Management Accounting Services
1. Product cost under absorption costing is
characteristically:
A.Higher than under variable costing.
B.Lower than under variable costing.
C.Equal to variable costing.
D.Higher sometimes and lower sometimes than variable
costing.
Solution: A is correct.
2. NFJPIA Co. is considering the following investment proposals.
Rank the following proposals using the profitability index (in
order of the most profitable proposal down to the least profitable
proposal).
ABCD
Investment required160,000200,000120,000150,000
Present value of future net cash
flows192,000300,000168,000240,000
A.D, B, C, A
B.B, D, C, A
C.B, D, A, C
D.A, C, B, D
Solution: A is correct.Profitability index is an investment
appraisal technique calculated by dividing the present value of
future cash flows of a project by the initial investment required
for the project. Profitability index of the above proposals are as
follows:Decision Rule. Accept a project if the profitability index
is greater than 1, stay indifferent if the profitability index is
zero and don't accept a project if the profitability index is below
1. The ranking of the proposals in terms of preference using the
profitability index is determined as follows.
ABCD
Present value of future net cash
flows192,000300,000168,000240,000
Investment required160,000200,000120,000150,000
Profitability index1.21.51.41.6
3. The stock of GVS pays dividends that are expected to grow at
a steady rate of 3.2% per year. Investors expect a rate of return
of 11.5% from GVS stock. If the spread between this required rate
of return and the dividend growth rate were to increase by 50 basis
points, the percentage change in the stock price would be:
A.+3.94%
B.-4.73%
C.-5.68%
D.+4.22%
Solution: C is correct.
Thedividend discount model(DDM) is a method of valuing a company
based on the theory that astockis worth the discounted sum of all
of its future dividend payments. In other words, it is used to
value stocks based on thenet present valueof the
futuredividends.
Using Dividend Discount Model given Po = D1/(k g). When k g =
11.5% - 3.2% = 8.3%, the price is given by Po = D1/0.083. When the
spread increases by 50 basis points and all else stays constant,
the price becomes P1= D1/(0.083 + 0.005) = D1/0.088. The percentage
change in the price equals (P1 Po)/Po = (1/0.088 1/0.083)*0.083 =
0.083/0.088 1 = -5.68%. Thus, the stock price falls by 5.68% when
the spread between k and g increases by 50 basis points, all else
equal.
4. Which of the following statements is true?A.A firm with
financial leverage has a larger equity multiplier than an otherwise
identical firm with no debt in its capital structure.
B.The use of debt in a companys capital structure results in tax
benefits to the investors who purchase the companys bonds.
C.All else equal, a firm with a higher debt ratio will have a
lower basic earning power ratio.
D.All of the statements above are correct.
Solution: A is correct.
A firm with financial leverage means the firm uses debt for
financing. Equity multiplier is a measure of financial leverage,
calculated as: Total Assets / Total Stockholders' Equity.
Like all debt management ratios, the equity multiplier is a way
of examining how a company uses debt to finance its assets. It is
also known as the financial leverage ratio or leverage ratio. A
higher equity multiplier indicates higher financial leverage, which
means the company is relying more on debt to finance its
assets.
The use of debt provides tax benefits to the corporations that
issue debt, not to the investors who purchase debt (in the form of
bonds).
The basic earning power ratio is calculated as the ratio of
Earnings Before Interest and Taxes to Total Assets. The higher the
BEP ratio, the more effective a company is at generating income
from its assets. BEP is useful for comparing firms with different
tax situations and different degrees of financial leverage. The
basic earning power ratio would be the same if the only thing that
differed between the firms were their debt ratios.Choice A is
correct. Other choices are false.
5. The issuance of serial bonds in exchange for an office
building, with the first installment of the bonds due late this
year:
A.Decreases net working capital
B.Decreases the current ratio
C.Decreases the quick ratio
D.Affects all of the answers as indicated
Solution: D is correct
D is correct because the first installment is a current
liability which affects the quick ratio, the current ratio, and
working capital.
6. The internal rate of return is theA.Rate of interest that
equates the present value of cash outflows and the present value of
cash inflows
B.Minimum acceptable rate of return for a proposed
investment
C.Risk-adjusted rate of return
D.Required rate of return
Solution: A is correct.
7. An analyst has obtained the following information regarding
two companies, Company X and Company Y:
Company X and Company Y have the same total assets.
Company X has a higher interest expense than Company Y.
Company X has a lower operating income (EBIT) than Company
Y.
Company X and Company Y have the same return on equity
(ROE).
Company X and Company Y have the same total assets turnover
(TATO).
Company X and Company Y have the same tax rate.
Based on the above information, which of the following
statements is true?
A.Company X has a higher times interest earned ratio.
B.Company X and Company Y has the same debt ratio.
C.Company X has a higher return on assets.
D.Company X has a lower profit margin.
Solution: D is correct.
Times interest earned (also called interest coverage ratio) is
the ratio of earnings before interest and tax (EBIT) of a business
to its interest expense during a given period. It is a solvency
ratio measuring the ability of a business to pay off its debts.X
has a lower net income considering it has a lower EBIT and higher
interest than Y, but the same tax rate as Y. Sales for each company
are the same because they have the same total assets and the same
total assets turnover ratio (TATO = Sales/TA). Therefore, since X
has a lower net income and same sales as Y, it follows that it has
a lower profit margin (Net Income /Sales).
8. Which of the following statements relating to breakeven point
analysis is correct?
Statement 1Breakeven point is not a good planning tool since the
goal of business is to make a profit.
Statement 2Focusing on target net income rather than operating
income will increase the breakeven point.
Statement 3Companies with a greater proportion of fixed costs
have a greater risk of loss than companies with a greater
proportion of variable costs.
Statement 4Breakeven point is the level of sales at which profit
is zero.
A.False, False, True, True
B.False, True, True, True
C.True, True, False, False
D.True, False, False, False
E.All statements are true.
Solution: A is correct.
Statement 1 is false - breakeven point is an important planning
tool that helps managers determine volume of sales/production
needed to be profitable.
Statement 2 is false - the same breakeven point will be
calculated whether target operating income or target net income is
used in the CVP calculation.
Statements 3 and 4 are correct.
9. A call option on a share of common stock is more valuable
when there is lower
A.Market value of the underlying share
B.Exercise price on the option
C.Time to maturity on the option
D.Variability of market price on the underlying share
Answer: B. Exercise price on the option.
Source: Wiley CPA Exam Review Business Environment and Concepts
by Whittington and Delaney (2005)
10. Which of the following will cause a shift in the supply
curve of a product?
A.Changes in consumer tastes
B.Changes in the number of buyers in the market
C.Changes in production taxes
D.Changes in the price of the product
Answer: C. Changes in production taxes
A shift in the supply curve may result from:(1) changes in
production technology(2) changes or expected changes in resource
prices(3) changes in the prices of other goods(4) changes in taxes
or subsidies(5) changes in the number of sellers in the market(6)
expectations about the future price of the product
A.Incorrect. Changes in consumer tastes will result in a shift
in demand curve.
B.Incorrect. Changes in the number of buyers in the market will
result in a shift in demand curve.
C.Correct. Changes in production taxes will alter the supply
curve.
D.Incorrect. Change in the price of the product involves
movement along the existing supply curve, not a shift in the supply
curve.
Source: Wiley CPA Exam Review Business Environment and Concepts
by Whittington and Delaney (2005)
11. Operational budgets are used by a retail company for
planning and controlling its business activities. Data regarding
the companys monthly sales for the last 6 months of the year and
its projected collection patterns are shown below.
The cost of merchandise averages 40% of its selling price. The
companys policy is to maintain an inventory equal to 25% of the
next months forecasted sales. The inventory balance at cost is
Php80,000 as of June 30.
Forecasted sales
JulyPhp775,000
August750,000
September825,000
October800,000
November850,000
December900,000
What is the budgeted cost of the companys purchase for the month
of August?
A. Php307,500B. Php300,000C. Php450,500D. Php142,500
Answer: A. Php307,500
Sales (Php750,000 40%)Php300,000
Ending inventory (Php825,000 40% 25%) 82,500
Beginning inventory (Php750,000 40% 25%)(75,000)
PurchasesPhp307,500
Source: Wiley CPA Exam Review Business Environment and Concepts
by Whittington and Delaney (2005)
12. The management of ABC Corporation has decided to implement a
transfer pricing system. ABCs MIS department is currently
negotiating a transfer price for its services with the four
producing divisions of the company as well as the marketing
department. Charges will be assessed based on number of reports
(assume that all reports require the same amount of time and
resources to produce). The cost to operate the MIS department at
its full capacity of 1,000 reports per year is budgeted at
Php450,000. The user subunits expect to request 250 reports each
this year. The cost of temporary labor and additional facilities
used to produce reports beyond capacity is budgeted at Php480.00
per report. ABC could purchase the same services from an external
Information Services firm for Php700,000. What amounts should be
used as the floor and the ceiling in determining the negotiated
transfer price?FloorCeilingA. Php450Php500B. Php456Php560C.
Php540Php500D. Php500Php540
Answer: B. Floor Php456.00; Ceiling Php560.00
Negotiated transfer prices should fall within a range limited by
a ceiling and a floor. The ceiling is the lowest market price that
could be obtained from an external supplier, and the floor equals
the outlay costs plus opportunity cost of the transferring
division. Since ABCs MIS department does not have the option to
sell services to external customers, its opportunity cost is Php0.
Since all costs of service departments must be covered by the
revenue-producing departments, the MIS departments outlay cost
equals its total costs. The departments full capacity level is
1,000 reports per year. However, the user departments will be
requesting 1,250 reports (5 user subunits 250 reports each). Thus,
the MIS department will incur costs of Php120,000 [Php480 (1,250
1,000)] for the 250 reports above capacity, in addition to the
Php450,000 budgeted costs for full capacity. The total cost of
Php570,000 (Php450,000 + Php120,000) is used to calculate the
floor. The ceiling is based on the Php700,000 that would be
incurred to purchase MIS services externally. Since the MIS
department will be producing 1,250 reports, the floor is Php456.00
(Php570,000 1,250), and the ceiling is Php560.00 (Php700,000
1,250). At full capacity, any differential costs of additional
production are added to the floor. Php480.00 represents only the
differential cost of producing each report above full capacity, not
cost per report for total production. Budgeted costs are based on
production of 1,250 reports, not 1,000.
Source: Wiley CPA Exam Review Business Environment and Concepts
by Whittington and Delaney (2005)
13. ABC Company has a single product called JGH. The company
normally produces and sells 70,000 JGHs each year at a selling
price of Php45.00 per unit. The companys unit costs at this level
of activity are given below:
Direct materialsPhp10.00
Direct labor3.50
Variable manufacturing overhead6.80
Fixed manufacturing overhead8.00
Variable selling expenses2.00
Fixed selling expenses3.00
Total cost per unitPhp33.30
Assume that ABC Company has sufficient capacity to produce
100,000 units of JGH each year without any increase in fixed
manufacturing overhead costs. The company could increase its sales
by 30% above the present 70,000 units each year if it were willing
to increase the fixed selling expenses by Php100,000.
How much would be the increase in income if the production and
sales are increased by 30%?
A. Php376,700B. Php300,000C. Php465,600D. Php356,750
Answer: A. Php376,700
Selling pricePhp45.00
Variable expenses
Direct materialsPhp10.00
Direct labor3.50
Variable manufacturing overhead6.80
Variable selling expenses2.0022.30
Unit contribution marginPhp22.70
Additional contribution (70,000 units 30%
Php22.70)Php476,700
Less: Additional fixed selling costs100,000
Additional incomePhp376,700
Source: Comprehensive Review in MAS (2007) by Bobadilla
14. Combo Music Company produces and sells sensitive precision
instruments for industrial use. Four types of instruments are
produced at Canlubang Plant. Data with respect to these four types
of products are given below:
Product Line
1234
Time required to make such unit (in minutes)20401060
Selling price per unit24341640
Variable cost per hour108487220
The Company has 24,000 production hours available after meeting
the requirements for the regular market. The market can absorb all
units of any product line that is produced with one exception -
only 48,000 units of Product 3 can be sold. In addition, there is a
shortage of materials for Product 4. Materials are available for
the production of a total of 12,000 units of Product 4.What is the
number of hours available for Product 2 to maximize profit while
observing all the restrictions?A.6,000 hours
B.4,000 hours
C.3,000 hours
D.0 hours
Answer: B. 4,000 hours.
Product Line
1234
Total minutes in an hour60606060
Divided by: Minutes to make each unit20401060
Units produced each hour31.561
Multiplied by: Unit selling price24341640
Sales per hour72519640
Variable cost per hour108487220
Contribution margin per hour(36)32420
Product ranking of production and sales to achieve the best
productcombination and thus maximize profit:
Product 1will not be manufactured
Product 23rd
Product 31st
Product 42nd
Allocation of 24,000 production hours:
Product Line
1234
Product 3 (48,000 10/60)8,000
Product 412,000
Product 2 Remainder4,000
Product 1 None
Total allocated hours04,0008,00012,000
Source: Reviewer in MAS by Morante
15. Which of the following statements regarding transfer pricing
is false?
A.When idle capacity exists, there is no opportunity cost to
producing intermediate products for another division.
B.Market-based transfer prices should be reduced by any costs
avoided by selling internally rather than externally.
C.No contribution margin is generated by the transferring
division when variable cost-based transfer prices are used.
D.The goal of transfer pricing is to provide segment managers
with incentive to maximize the profits of their divisions.
Solution: D is correct
The goal of transfer pricing is to encourage managers to make
transfer decisions which maximize profits of the company as a
whole. Some transfers may not be profitable to a particular
division, but would effect a cost savings to the company by
avoiding costs of purchasing externally. For example, when a
division is already operating at full capacity and uses variable
cost transfer prices, additional production for internal transfer
would result in a loss for the transferring division because no
contribution margin is earned to cover the differential fixed costs
incurred. Conversely, internal production may be cheaper to the
corporate entity than purchasing the product, in which case the
division should accept the order. However, the division manager is
likely to engage in suboptimization by rejecting the order to
enhance the divisions performance, while adversely affecting
overall company performance.
Business Law and Taxation
1. Marsh offered to construct the house of Mellow for
Php900,000, giving the latter ten (10) days within which to accept
or reject the offer. On the fifth day, before Mellow could make up
his mind, Marsh withdrew his offer. Which of the following is
true?A. The withdrawal of Marshs offer will cause the offer to
cease in law, hence, there could be no concurrence of the offer and
the acceptance;B. In the absence of concurrence of offer and
acceptance, there can be no consent;C. Without consent, there is no
perfected contract for the construction of the house of Mellow.D.
All of the above.
Answer: d) All of the above.
Article 1318 of the Civil Code There is no contract unless the
following requisites concur:(1) Consent of the contracting
parties;(2) Object certain which is the subject matter of the
contract;(3) Cause of the obligation which is established.
Article 1319 of the Civil Code Consent is manifested by the
meeting of the offer and the acceptance upon the thing and the
cause which are to constitute the contract. The offer must be
certain and the acceptance absolute. A qualified acceptance
constitutes a counter offer. Xxx.
2. W, X, and Y are partners. X conveyed his share to Z.
Thereafter, the partnership incurred liabilities for the contract
entered into between the partnership and M prior to the sale of Xs
share to Z. Which of the following statements is correct?A. Z
cannot be held liable to M because a partner admitted into a
partnership shall become liable for an obligation only from the
time he took part in the control of the business.B. Z cannot be
held liable to M because as a partner, Z shall be subject to all
the restrictions and liabilities of a partnership.C. Z can be held
liable pro-rata with the other partners regardless of the time the
liability was incurred.D. Z can be held liable to M, but his
liability shall be satisfied only out of partnership property,
unless there is a stipulation to the contrary.
Answer: D Z can be held liable to M, but his liability shall be
satisfied only out of partnership property, unless there is a
stipulation to the contrary.
Article 1826 of the Civil Code provides: A person admitted as a
partner into an existing partnership is liable for all the
obligations of the partnership arising before his admission as
though he had been a partner when such obligations were incurred,
except that his liability shall be satisfied only out of
partnership property, unless there is a stipulation to the
contrary.
3. ABC owns 15% of the subscribed capital stock of XYZ
corporation which owns an office building. ABC owns a security and
janitorial agency. ABC, a director of XYZ Corporation, engaged the
services of his own company to perform services to the office
building. Which of the following conditions is NOT required in
order for the service contract between ABC and XYZ to be valid?A.
The service contract must be approved by the board of directors of
XYZ corporation;B. ABCs vote was not necessary to constitute a
quorum at the meeting of the board of directors;C. ABCs vote was
not necessary for the approval of the service contracts.D. The
service contract must be ratified by all the stockholders of the
corporation.
Answer: D The service contract must be ratified by all the
stockholders of the corporation.
Section 32 of the Corporation Code provides: A contract of the
corporation with one or more of its directors or trustees or
officers is voidable, at the option of such corporation, unless all
the following conditions are present:1. That the presence of such
director of trustee in the board meeting in which the contract was
approved was not necessary to constitute a quorum for such
meeting;2. That the vote of such director or trustee was not
necessary for the approval of the contract;3. That the contract is
fair and reasonable under the circumstances; and4. That in the case
of an officer, the contract has been previously authorized by the
board of directors.Where the first two conditions set forth in
preceding paragraph is absent, in case of a contract with a
director or trustee, such contract may be ratified by the vote of
the stockholders representing at least two-thirds of the
outstanding capital stock or of at least two thirds of the members
in a meeting called for the purpose: Provided, That full disclosure
of the adverse interest of the directors or trustees involved is
made at such meeting: Provided, however, That the contract is fair
and reasonable under the circumstances.
4. In line with the Trust Fund Doctrine that generally renders
it unlawful for the corporation to return assets to the
stockholders representing capital, under what conditions may a
stock corporation acquire its own shares:A. There exists in the
corporate books unrestricted retained earnings to cover the
repurchase of shares;B. The repurchase of shares must be for a
legitimate business purpose;C. Both A and B.D. Neither A nor B.
Answer: C Both A and B.
Section 41 of the Corporation Code provides: A stock corporation
shall have the power to purchase or acquire its own shares for a
legitimate corporate purposes or purposes, including but not
limited to the following cases: Provided, That the corporation has
unrestricted retained earnings in its books to cover the shares to
be purchased or acquired:a. To eliminate fractional shares arising
out of stock dividends;b. To collect or compromise an indebtedness
to the corporation, arising out of unpaid subscription, in a
delinquency sale, and to purchase delinquent shares sold during
said sale; andc. To pay dissenting or withdrawing stockholders
entitled to payment for their shares under the provisions of this
Code.
5. In a stockholders meeting, Mr. Bean dissented from the
corporate act converting preferred voting shares to non-voting
shares. Mr. Bean submitted his certificates of stock for notation
that his shares are dissenting. The next day, Mr. Bean transferred
his shares to Ms. Dora to whom new certificates were issued. Which
of these statements is correct?A. Mr. Bean can exercise the right
of appraisal because he dissented from the corporate act.B. Mr.
Bean can no longer exercise the right of appraisal because he
already transferred his shares to Ms. Dora.C. Ms. Dora should
exercise the right of appraisal on behalf of Mr. Bean.D. None of
the statements is correct.
Answer: B. Mr. Bean can no longer exercise the right of
appraisal because he already transferred his shares to Ms.
Dora.
Section 86 of the Corporation Code provides: Within ten (10)
days after demanding payment for his shares, a dissenting
stockholder shall submit the certificates of stock representing his
shares to the corporation for notation thereon that such shares are
dissenting shares. His failure to do so shall, at the option of the
corporation, terminate his rights under this Title. If shares
represented by the certificates bearing such notation are
transferred, and the certificates consequently cancelled, the
rights of the transferor as a dissenting stockholder under this
Title shall cease and the transferee shall have all the rights of a
regular stockholder; and all dividend contributions which would
have accrued on such shares shall be paid to the transferee.
6. ABC Corporation has 10 members in the Board of Directors.
During the election of officers, one of its members got sick, while
the other two went abroad, thus, the three of them failed to attend
the meeting and cast their vote. Nonetheless, A acquired four votes
for the position of Secretary. Is A validly elected as an
officer?A. No. The Code requires the vote of majority of all the
members of the Board of Directors.B. Yes. The Code requires only
the decision of at least a majority of directors present at the
election.C. Yes. The articles of incorporation or by-laws may
provide for lesser majority in case of election of officers.D. No.
The articles of incorporation require the quorum.
Answer: A. No. The Code requires the vote of majority of all the
members of the Board of Directors.
Section 25 of the Corporation Code: Immediately after their
election, the directors of a corporation must formally organize by
the election of a president, who shall be a director, a treasurer
who may or may not be a director, a secretary who shall be a
resident and citizen of the Philippines, and such other officers as
may be provided for in the by-laws. Any two or more positions may
be held concurrently by the same person, except that no one shall
act as president and secretary or as president and treasurer at the
same time.
The directors or trustees and officers to be elected shall
perform the duties enjoined on them by law and by the by-laws of
the corporation. Unless the articles of incorporation or the
by-laws provide for a greater majority, a majority of the number of
directors or trustees as fixed in the articles of incorporation
shall constitute a quorum for the transaction of corporate
business, and every decision of at least a majority of the
directors or trustees present at a meeting at which there is a
quorum shall be valid as a corporate act, except for the election
of officers which shall require the vote of a majority of all the
members of the board.
Directors or trustees cannot attend or vote by proxy at board
meetings.
7. A, B, C, D, and E entered into a contract of partnership to
organize events such as weddings and birthday celebrations. A and B
are the only limited partners. During one of the parties that the
partnership organized, D totally forgot her task to turn on the
lights during the entrance of the debutant. As a result, the
debutant slipped off injuring her ankle. The victim sues the
partnership for damages. Choose the best answer.A. A and B are not
liable because they are limited partners.B. The partnership is
liable for damages to the same extent as D.C. Only the general
partners are liable in equal proportion.D. Only D is liable.
Answer: B. The partnership is liable for damages to the same
extent as D.
Article 1822 of the Civil Code provides: Where, by any wrongful
act or omission of any partner acting in the ordinary course of the
business of the partnership or with the authority of his
co-partners, loss or injury is caused to any person, not being a
partner in the partnership, or any penalty is incurred, the
partnership is liable therefor to the same extent as the partner so
acting or omitting to act.
8. X owes Y Php100,000 payable in one year, at 10% interest per
annum. On maturity, X pays Y Php50,000 which Y acknowledged having
received without mentioning the payment of interest. Which of the
following is correct?A. Principal has already been paid.B. Interest
is waived.C. Payment will be applied first to the interest.D.
Obligation is extinguished.
Answer: C. Payment will be applied first to the interest.
Article 1253 of the Civil Code provides: If the debt produces
interest, payment of the principal shall not be deemed to have been
made until the interests have been covered.
9. ABC Corporation is a stock corporation whose principal place
of business is in Quezon City. If a regular meeting of its
stockholders shall be held, one of the requirements is:A. Notice of
meetings must be published in a newspaper of general circulation
two weeks before the scheduled meeting.B. Quorum must consist of
all the stockholders.C. Written notice of meetings shall be sent at
least two weeks prior to the meeting, unless a different period is
required by the by-laws.D. All of the above.
Answer: C. Written notice of meetings shall be sent at least two
weeks prior to the meeting, unless a different period is required
by the by-laws.
Section 50 of the Corporation Code provides: Regular meetings of
stockholders or members shall be held annually on a date fixed in
the by-laws, or if not so fixed, on any date in April of every year
as determined by the board of directors or trustees: Provided, That
written notice of regular meetings shall be sent to all
stockholders or members of record at least two (2) weeks prior to
the meeting unless a different period is required by the
by-laws.
Special meetings of stockholders or members shall be held at any
time deemed necessary or as provided in the by-laws; Provided,
however, That at least one (1) week written notice shall be sent to
all stockholders or members, unless otherwise provided in the
by-laws. Xxx.
10. XYZ Corporations by-laws provide that A, one of its
directors, shall receive 10% of the net income before tax of the
corporation as his yearly compensation. However, B, the
Corporations president, contends that such provision directly
violates the Code prohibiting the compensation of directors. Are
directors absolutely not entitled to compensation?A. Yes. The Code
expressly provides that directors shall not receive any
compensation, except for reasonable per diems.B. No. Directors are
entitled to compensation when authorized by the by-laws or by vote
of stockholder representing at least majority of the outstanding
capital stock, subject to limitations that the total yearly
compensation must exceed 10% of the net income before income tax of
the compensation during the preceding year.C. No. Directors are
entitled when authorized by the by-laws or by vote of stockholders
representing at least majority of the outstanding capital stock,
subject to limitations that the total yearly compensation shall not
exceed 10% of the net income before tax of the corporation during
the preceding year.D. Yes. Directors are not entitled to
compensation.
Answer: C. No. Directors are entitled when authorized by the
by-laws or by vote of stockholders representing at least majority
of the outstanding capital stock, subject to limitations that the
total yearly compensation shall not exceed 10% of the net income
before tax of the corporation during the preceding year.
Section 30 of the Corporation Code provides: Compensation of
directors. -- In the absence of any provision in the by-laws fixing
their compensation, the directors shall not receive any
compensation, as such directors, except for reasonable per diems:
Provided, however, That any such compensation other than per diems
may be granted to directors by the vote of the stockholders
representing at least a majority of the outstanding capital stock
at a regular or special stockholders meeting. In no case shall the
total yearly compensation of directors, as such directors, exceed
ten percent (10%) of the net income before income tax of the
corporation during the preceding year.
11. Employee J, a resident Filipino citizen, is a teacher in
Monsters University. He earns a monthly salary of P25,000. For the
year 2012, he also received a discretionary bonus amounting to
P40,000. His wife, K, gave birth to their fourth child. The names
of their children and the birthdays are as follows:
Ethel3/11/1991
Luz6/14/1998
Edmond6/19/2006
Grace9/15/2012
For the year ended 2012, how much basic personal exemption can
Employee J claim?
A. P150,000 B. P125,000 C. P100,000 D. P50,000 E. Zero
Answer: D. P50,000
12. Co. C had the following data in the month of
September:SalesP1,900,000
Purchases of goods 1,260,000
Purchase of machines 1,440,000
Machine Life8 years
Assuming that the said transactions are properly substantiated
for VAT purposes, compute the VAT payable. Note: The amounts are
exclusive of VAT.A. Php70,920B. Php76,800C. Php73,920D.
Php225,120Answer: C. P73,920
Output VAT (P1,900,000 x 12%) 228,000
Input VAT
Purchase of goods (P1,260,000 x 12%) 151,200
Purchase of machines* (P1,440,000 x 12%/60 months) 2,880
154,080
Net VAT Payable 73,920
13. On July 31, 2013, Esperanza received a preliminary
assessment notice from the BIR demanding that she pays P180,000.00
deficiency income taxes on her 2011 income. How many days from July
31, 2013 should Esperanza respond to the notice?A. 180 daysB. 30
daysC. 60 daysD. 15 days
Answer: D. 15 days
14. The gross estate of Ms. Layda amounted to P5 million. The
actual funeral expenses are as follows:
Mourning apparel of the surviving spouse P100,000
Mourning apparel of married children90,000
Publication charges for death notices 70,000
Interment and/or cremation fees and charges50,000
Total310,000
How much is the total deductible funeral expense?A. P250,000B.
P200,000C. P270,000D. P180,000
Answer: B. P200,000
Actual funeral expenses
Mourning apparel of the surviving spouse 100,000
Publication charges for death notices 70,000
Interment and/or cremation fees and charges 50,000
220,000
5% of gross estate 250,000
Limit 200,000
15. Gianna Corporation is engaged in the business of publishing
magazines as well as the merchandising of office supplies. For CY
2012, it has the following revenue/sales:
Revenue from magazines 587,400
Sales from office supplies 197,500
Further, Gianna incurred entertainment, amusement and recreation
expenses (EAR) amounting to P8,350 and 2/3 of which was incurred
for the publishing of magazines. How much EAR is deductible for
income tax purposes?
A. P8,657.33 B. P8,350.00 C. P6,861.50 D. P6,554.17
Answer: D. P6,554.17
RevenueActual EAREAR LIMITDeductible EAR
Revenue from magazines 587,4002/3 5,566.67 5,874.00 (1% of
revenue from magazines) 5,566.67
Sales from office supplies 197,5001/3 2,783.33 987.50 (0.5% of
sales from office supplies) 987.50
8,350.00 6,554.17
Theory of Accounts
1. This refers to IASBs main vehicle for consulting the public
and sets out a specific proposal in the form of a proposed IFRS (or
amendment to an IFRS).A. Final StandardsB. Due Process HandbookC.
AmendmentsD. Exposure Draft
Answer: D. Exposure Draft
Due Process Handbook for the IASB and IFRS Interpretations
Committee (February 2013) provides:
An Exposure Draft is the IASBs main vehicle for consulting the
public and therefore includes an invitation to comment, setting out
the issues that the IASB has identified as being of particular
interest. Although it is normally included with the ballot draft,
it is not necessary for the IASB to ballot the invitation to
comment. (Par.6.3)
An Exposure Draft sets out a specific proposal in the form of a
proposed Standard (or amendment to a Standard) and is therefore
generally set out in the same way as, and has all of the components
of, a Standard. (Par. 6.2)
2. Which of the following is not an indicator of situations that
would individually or in combination lead to a lease being
classified as a finance lease?
A.The leased assets are of such a specialized nature that only
the lessee can use them without major modifications.
B.Gains or losses from the fluctuation in the fair value of the
residual accrue to the lessor.
C.The lessee has the ability to continue the lease for a
secondary period at a rent that is substantially lower than market
rent.
D.If the lessee can cancel the lease, the lessor's losses
associated with the cancellation are borne by the lessee.
Answer: B. Gainsor losses from the fluctuation in the fair value
of the residual accrue to the lessor.
Paragraphs 10-11 of PAS 17, Leases state:
Whether a lease is a finance lease or an operating lease depends
on the substance of the transaction rather than the form of the
contract.1 Examples of situations that individually or in
combination would normally lead to a lease being classified as a
finance lease are:(a) the lease transfers ownership of the asset to
the lessee by the end of the lease term;(b) the lessee has the
option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option
becomes exercisable for it to be reasonably certain, at the
inception of the lease, that the option will be exercised;(c) the
lease term is for the major part of the economic life of the asset
even if title is not transferred;(d) at the inception of the lease
the present value of the minimum lease payments amounts to at least
substantially all of the fair value of the leased asset; and(e) the
leased assets are of such a specialized nature that only the lessee
can use them without major modifications.
Indicators of situations that individually or in combination
could also lead to a lease being classified as a finance lease
are:(a) if the lessee can cancel the lease, the lessor's losses
associated with the cancellation are borne by the lessee;(b) gains
or losses from the fluctuation in the fair value of the residual
accrue to the lessee (for example, in the form of a rent rebate
equaling most of the sales proceeds at the end of the lease);
and(c) the lessee has the ability to continue the lease for a
secondary period at a rent that is substantially lower than market
rent.
3. Which of the following statement(s) is/are incorrect?
Statement I: PAS 17, Leases, permits initial direct costs
incurred by lessors in negotiating an operating lease to be charged
as expenses when incurred.
Statement II: It is mandatory to apply the finance lease
accounting methodology set out in PAS 17 to investment properties
held under operating leases.
A.None of the above
B.Statement I only
C.Statement II only
D.Statements I and II
Answer: B. Statement I only
Paragraph 52 of PAS 17 provides:Initial direct costs incurred by
lessors in negotiating and arranging an operating lease shall be
added to the carrying amount of the leased asset and recognized as
an expense over the lease term on the same basis as the lease
income.
Paragraph IN5 of PAS 17 provides:Although PAS 40, Investment
Property prescribes the measurement models that can be applied to
investment properties held, it requires the finance lease
accounting methodology set out in this Standard to be used for
investment properties held under leases.
Paragraph 25 of PAS 40 provides:The initial cost of a property
interest held under a lease and classified as an investment
property shall be as prescribed for a finance lease by paragraph 20
of PAS 17, i.e., the asset shall be recognized at the lower of the
fair value of the property and the present value of the minimum
lease payments. An equivalent amount shall be recognized as a
liability in accordance with that same paragraph.
4. Which of the following statement(s) regarding impairment
testing under PAS 36, Impairment of Assets, is/are correct?
Statement I: Value in use is the undiscounted future cash flows
expected to be derived from an asset or cash-generating unit.
Statement II: When the amount estimated for an impairment loss
is greater than the carrying amount of the asset to which it
relates, an entity shall automatically recognize a liability.
Statement III: If it is not possible to estimate the recoverable
amount of an individual asset, the entity should determine the
recoverable amount of the cash generating unit to which the asset
belongs.
Statement IV: PAS 36 requires an intangible asset with an
indefinite useful life to be tested for impairment annually by
comparing its carrying amount with its recoverable amount,
irrespective of whether there is any indication that it may be
impaired. However, the most recent detailed calculation of such an
asset's recoverable amount made in a preceding period may be used
in the impairment test for that asset in the current period as long
as certain criteria provided by PAS 36 are met.
A.Statements III and IV
B.Statements II, III and IV
C.Statements I and III
D.Statements I, III and IV
Answer: A. Statements III and IV
Par. 6 of PAS 36, Impairment of Assets, provides:Value in use is
the present value of the future cash flows expected to be derived
from an asset or cash-generating unit.
Par. 62 of PAS 36, Impairment of Assets, provides:When the
amount estimated for an impairment loss is greater than the
carrying amount of the asset to which it relates, an entity shall
recognize a liability if, and only if, that is required by another
Standard.
Par. 22 of PAS 36, Impairment of Assets, provides:Recoverable
amount is determined for an individual asset, unless the asset does
not generate cash inflows that are largely independent of those
from other assets or groups of assets. If this is the case,
recoverable amount is determined for the cash-generating unit to
which the asset belongs
Par. 24 of PAS 36, Impairment of Assets, provides:Paragraph 10
requires an intangible asset with an indefinite useful life to be
tested for impairment annually by comparing its carrying amount
with its recoverable amount, irrespective of whether there is any
indication that it may be impaired. However, the most recent
detailed calculation of such an asset's recoverable amount made in
a preceding period may be used in the impairment test for that
asset in the current period, provided all of the following criteria
are met:(a) if the intangible asset does not generate cash inflows
from continuing use that are largely independent of those from
other assets or groups of assets and is therefore tested for
impairment as part of the cash-generating unit to which it belongs,
the assets and liabilities making up that unit have not changed
significantly since the most recent recoverable amount
calculation;(b) the most recent recoverable amount calculation
resulted in an amount that exceeded the asset's carrying amount by
a substantial margin; and(c) based on an analysis of events that
have occurred and circumstances that have changed since the most
recent recoverable amount calculation, the likelihood that a
current recoverable amount determination would be less than the
asset's carrying amount is remote.
5. Which of the following are considered adjusting events after
the reporting period in accordance with PAS 10, Events after the
Reporting Period?
I. Bankruptcy of a customer that occurs after the reporting
periodII. Decline in market value of investments III. Declaration
of dividends to holders of equity instruments after the reporting
periodIV. Determination after the reporting period of the amount of
profit-sharing or bonus payments, if the entity had a present legal
or constructive obligation at the end of the reporting period to
make such payments as a result of events before that dateV.
Abnormally large change in asset prices or foreign exchange
rates
A.Statements I, IV and V
B.Statements I, II and IV
C.Statements I and IV
D.Statements I, II, IV and V
Answer: C. Statements I and IV
Paragraph 9 of PAS 10, Events after the Reporting Period
provides the following examples of adjusting events after the
reporting period as follows:(a) the settlement after the reporting
period of a court case that confirms that the entity had a present
obligation at the end of the reporting period. The entity adjusts
any previously recognized provision related to this court case in
accordance with PAS 37, Provisions, Contingent Liabilities and
Contingent Assets or recognizes a new provision. The entity does
not merely disclose a contingent liability because the settlement
provides additional evidence that would be considered in accordance
with paragraph 16 of PAS 37.
(b) the receipt of information after the reporting period
indicating that an asset was impaired at the end of the reporting
period, or that the amount of a previously recognized impairment
loss for that asset needs to be adjusted. For example:
(i) the bankruptcy of a customer that occurs after the reporting
period usually confirms that a loss existed at the end of the
reporting period on a trade receivable and that the entity needs to
adjust the carrying amount of the trade receivable; and
(ii) the sale of inventories after the reporting period may give
evidence about their net realizable value at the end of the
reporting period.
(c) the determination after the reporting period of the cost of
assets purchased, or the proceeds from assets sold, before the end
of the reporting period.
(d) the determination after the reporting period of the amount
of profit-sharing or bonus payments, if the entity had a present
legal or constructive obligation at the end of the reporting period
to make such payments as a result of events before that date (see
PAS 19, Employee Benefits).
(e) the discovery of fraud or errors that show that the
financial statements are incorrect.
6. When disclosing financial instruments, an entity shall group
them into classes as follows:
I.Group the financial instruments into classes that are
appropriate to the nature of the information disclosed and that
take into account the characteristics of those financial
instruments.
II.Group the financial instruments according to the categories
of financial instruments in PAS 39, Financial Instruments:
Recognition and Measurement.
III.Provide sufficient information to allow reconciliation to
the line items presented in the statement of financial
position.
A.I only.
B.I and II.
C.I and III
DI, II and III.
Answer C. I and III are true:
A.Incorrect. Although Statement I is correct such that PFRS 7
paragraph 6 provides that an entity shall group financial
instruments into classes that are appropriate to the nature of the
information disclosed and that take into account the
characteristics of those financial instruments, the standard also
requires that sufficient information shall be provided to permit
reconciliation to the line items presented in the statement of
financial position (Statement III).
B.Incorrect. Although Statement I is correct such that PFRS 7
paragraph 6 provides that an entity shall group financial
instruments into classes that are appropriate to the nature of the
information disclosed and that take into account the
characteristics of those financial instruments, grouping the
financial instruments into categories (Statement II) is not
consistent with the standards requirement to group financial
instruments into classes.
C.Correct. I and III are true. PFRS 7.6 provides that an entity
shall group financial instruments into classes that are appropriate
to the nature of the information disclosed and that take into
account the characteristics of those financial instruments. Also,
the standard requires that sufficient information shall be provided
to permit reconciliation to the line items presented in the
statement of financial position.
DIncorrect. Statements I and III are consistent with the
requirements in PFRS 7.6 about grouping financial instruments into
classes. However, grouping the financial instruments into
categories (Statement II) is not consistent with the standards
requirement to group financial instruments into classes. The
correct answer is C.
PFRS 7.6 provides when this PFRS requires disclosures by class
of financial instrument, an entity shall group financial
instruments into classes that are appropriate to the nature of the
information disclosed and that take into account the
characteristics of those financial instruments. An entity shall
provide sufficient information to permit reconciliation to the line
items presented in the statement of financial position.
7. Which of the following statement(s) is/are true?
Statement I:If an entity's interim financial report is in
compliance with PAS 34, Interim Financial Reporting, that fact
shall be disclosed. An interim financial report shall not be
described as complying with PFRSs unless it complies with some or
substantially all of the requirements of PFRSs.
Statement II:If an entity publishes a condensed set of financial
statements in its interim financial report, the form and content of
those statements shall always conform to the requirements of PAS 1,
Presentation of Financial Statements.
Statement III:Costs that are incurred unevenly during an
entity's financial year shall be anticipated or deferred for
interim reporting purposes if, and only if, it is also appropriate
to anticipate or defer that type of cost at the end of the
financial year.
A.Statement III only.
B.Statements I and II.
C.Statements II and III
D.Statements I, II and III.
Answer: A. Statement III only.
PAS 34 provides:
If an entity's interim financial report is in compliance with
this Standard, that fact shall be disclosed. An interim financial
report shall not be described as complying with PFRSs unless it
complies with all of the requirements of PFRSs (Par.19)
If an entity publishes a complete set of financial statements in
its interim financial report, the form and content of those
statements shall conform to the requirements of PAS 1 for a
complete set of financial statements. (Par. 9)
Costs that are incurred unevenly during an entity's financial
year shall be anticipated or deferred for interim reporting
purposes if, and only if, it is also appropriate to anticipate or
defer that type of cost at the end of the financial year. (Par.
39)
8. Which of the following statement(s) is/are incorrect in
accordance with PAS 28, Investment in Associates and Joint
Ventures?
Statement I:If an investment in an associate becomes an
investment in a joint venture, the entity continues to apply the
equity method and does not remeasure the retained interest.
Statement II: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 to the extent of the investors interest in the
associate.
A.All of the above.
B.Statement I only
C.Statement II only
D.None of the above.
Answer: C. Statement II only
PAS 28 states that:
Paragraph 24 - If an investment in an associate becomes an
investment in a joint venture or an investment in a joint venture
becomes an investment in an associate, the entity continues to
apply the equity method and does not remeasure the retained
interest.
Paragraph 29 - 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
9. Under the PAS 19, Employee Benefits (Revised), the following
are components of defined benefit costs under defined benefit
plans, except:
A.Service cost in profit or loss
B.Net interest on the net defined benefit liability in profit or
loss
C.Remeasurements of the net defined benefit liability (asset) in
other comprehensive income
D.Remeasurements of the net defined benefit liability (asset) in
profit or loss
Answer: D. Remeasurements of the net defined benefit liability
(asset) in profit or loss
Par. 120 of PAS19R states:An entity shall recognize the
components of defined benefit cost, except to the extent that
another PFRS requires or permits their inclusion in the cost of an
asset, as follows:(a) service cost (see paragraphs 66-112) in
profit or loss;(b) net interest on the net defined benefit
liability (asset) (see paragraphs 123-126) in profit or loss;
and(c) remeasurements of the net defined benefit liability (asset)
(see paragraphs 127-130) in other comprehensive income.
10. Which of the following is/are an example of a situation in
which offsetting is inappropriate?
Statement I: Financial assets and financial liabilities that
arise from financial instruments having the same primary risk
exposure (e.g., assets and liabilities within a portfolio of
forward contracts or other derivative instruments) but involve
different counterparties.
Statement II: Financial or other assets pledged as collateral
for non-recourse financial liabilities
Statement III: Obligations incurred as a result of events giving
rise to losses are expected to be recovered from a third party by
virtue of a claim made under an insurance contract.
Statement IV: The entity currently has a legally enforceable
right to set-off the recognized amounts and intends either to
settle on a net basis, or to realize the asset and settle the
liability simultaneously.
A.Statement I only
B.Statements I and II only
C.Statements I, II and II I only
D.Statements I, II, III and IV
Answer: C. Statements I, II and III only
Paragraph 49 of PAS 32, Financial Instruments: Presentation,
states that the conditions set out in paragraph 42 of PAS 32 are
generally not satisfied and offsetting is usually inappropriate
when:
(a) several different financial instruments are used to emulate
the features of a single financial instrument (a 'synthetic
instrument');(b) financial assets and financial liabilities arise
from financial instruments having the same primary risk exposure
(for example, assets and liabilities within a portfolio of forward
contracts or other derivative instruments) but involve different
counterparties;(c) financial or other assets are pledged as
collateral for non-recourse financial liabilities;(d) financial
assets are set aside in trust by a debtor for the purpose of
discharging an obligation without those assets having been accepted
by the creditor in settlement of the obligation (for example, a
sinking fund arrangement); or(e) obligations incurred as a result
of events giving rise to losses are expected to be recovered from a
third party by virtue of a claim made under an insurance
contract.
Practical Accounting 1
1. WXY Company has an overdue 8% note payable to First Bank at
Php8,000,000 and accrued interest of Php640,000. As a result of a
restructuring agreement entered on December 31, 2014, First Bank
agreed to the following:
a.The principal obligation is reduced to Php7,000,000.b.The
accrued interest of Php640,000 will be waived.c.The date of
maturity is extended to December 31, 2018.d.Annual interest of 10%
is to be paid in 4 years every December 31 starting in 2015.
The present value of 1 at 8% for 4 periods is 0.735 and the
present value of an ordinary annuity of 1 at 8% for 4 periods is
3.31. How much is the gain on extinguishment to be recognized for
2014 assuming that the prevailing market rate for similar note is
at 8%?
A.P1,178,000
B.P538,000
C.P1,641400
D.P0
Solution: A is correctOriginal principal Php8,000,000
Accrued interest 640,000
Carrying amount of overdue debt and interest Php8,640,00