IV AUDIT OF INVESTMENTS PROBLEM NO. 1 ... IV – AUDIT OF INVESTMENTS PROBLEM NO. 1 The following...

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IV – AUDIT OF INVESTMENTS

PROBLEM NO. 1

The following transactions of the Angat Company were completed during

the year 2006:

Jan. 2 Purchased 20,000 shares of Bulacan Auto Co. for P40 per

share plus brokerage costs of P4,500. These shares were

classified as trading securities.

Feb. 1 Purchased 20,000 shares of Malolos Company common stock at P125 per share plus brokerage fees of P19,000. Angat

classifies this stock as and available-for-sale security.

Apr. 1 Purchased P2,000,000 of RP Treasury 7% bonds, paying 102.5 plus accrued interest of P35,000. In addition, the company

paid brokerage fees of P18,000. Angat classified these bonds

as a trading security.

Jul. 1 Received semiannual interest on the RP Treasury Bonds.

Aug. 1 Sold P500,000 of RP Treasury 7% bonds at 103 plus accrued

interest.

Oct. 1 Sold 3,000 shares of Malolos at P132 per share.

The market values of the stocks and bonds on December 31, 2006, are as

follows:

Bulacan Auto Co. P45 per share

Malolos Company P130 per share

RP Treasury 7% bonds 102

QUESTIONS:

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

1. Gain or loss on sale of P500,000 RP Treasury Bonds on August 1, 2006 a. P15,000 gain c. P2,000 loss

b. P 2,500 gain d. P7,500 loss

2. Gain or loss on sale of 3,000 Malolos shares on October 1, 2006

a. P18,150 loss c. P 2,000 gain

b. P18,150 gain d. P21,000 gain

104

3. What amount of unrealized gain should be shown as component of

income in 2006?

a. P92,500 c. P74,500

b. P97,000 d. P80,000

4. What amount of unrealized gain should be shown as component of

equity as of December 31, 2006? a. P68,850 c. P66,000

b. P85,000 d. P 0

Suggested Solution:

Question No. 1

Sales proceeds (P500,000 x 1.03) P515,000

Less cost of RP Treasury bonds sold (P500,000 x 1.025)* 512,500

Gain on sale of P500,000 RP Treasury Bonds P 2,500

* PAS 39 par. 43 states that when a financial asset or financial liability is recognized initially, an entity shall measure it at its fair value plus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of financial asset or financial liability. Therefore, the transaction costs (e.g. brokerage fees) should be expensed for trading securities.

Question No. 2

Sales proceeds (3,000 shares x P132) P396,000

Less cost of shares sold

{[(20,000 x P125) + P19,000] x 3/20}

377,850

Gain on sale of 3,000 Malolos shares P 18,150

Question No. 3

Cost of Bulacan Auto Co. shares (20,000 x P40) P 800,000

Cost of RP Treasury 7% bonds (P2,000,000 x 1.025) 2,050,000

Cost of P500,000 RP Treasury bonds sold (see no. 1) ( 512,500)

Trading securities, 12/31/06 before mark-to-market 2,337,500

Fair value of trading securities, 12/31/06 (see below) 2,430,000

Unrealized gain on TS to be reported on the IS P 92,500

Bulacan Auto Co. (20,000 x P45) P 900,000

RP Treasury 7% bonds (P1,500,000 x 1.02) 1,530,200

Fair value of trading securities, 12/31/06 P2,430,000

105

Question No. 4

Cost of Malolos Company shares

[(20,000 x P125) + P19,000]

P2,519,000

Cost of 3,000 shares sold (see no. 2) (377,850)

AFS, 12/31/06 before mark-to-market 2,141,150

Fair value of AFS, 12/31/06 [(20,000 - 3,000) x P130] 2,210,000 Unrealized gain-AFS, 12/31/06 to be reported under SHE P 68,850

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

PROBLEM NO. 2

You were engaged by Balagtas Company to audit its financial statements

for the year 2006. During the course of your audit, you noted that the

following trading securities were properly reported as current assets at

December 31, 2005:

Cost Market France Corporation, 5,000 shares,

convertible preferred shares

P 450,000

P 487,500

Ces, Inc., 30,000 shares of common stock 675,000 742,500

Coo Co., 10,000 shares of common stock 618,750 450,000

P1,743,750 P1,680,000

The following sale and conversion transactions transpired during 2006:

Mar. 1 Sold 12,500 shares of Ces for P33.75 per share.

April 1 Sold 2,500 shares of Coo for P45 per share.

Sept. 21 Converted 2,500 shares of France’s preferred stock into

7,500 shares of France’s common stock, when the

market price was P78.75 per share for the preferred

stock and P47.25 per share for the common stock.

The following 2006 dividend information pertains to stocks owned by

Balagtas:

Jan. 2 Coo issued a 10% stock dividend when the market price

of Coo’s common stock was P49.50 per share.

March 31

and Sept. 30

France paid dividends of P2.50 per share on its preferred

stock, to stockholders of record on March 15 and

September 15, respectively. France did not pay

dividends on its common stock during 2006.

106

July 1 Ces paid a P2.25 per share dividend on its common

stock.

Market prices per share of the securities were as follows:

12/31/2006 12/31/2005

France Corp., preferred 92.25 97.50

France Corp., common 42.75 38.25

Ces, Inc., common 22.50 24.75

Coo Co., common 40.50 45.00

All of the foregoing stocks are listed in the Philippine Stock Exchange.

Declines in market value from cost would not be considered permanent.

QUESTIONS:

Based on the above and the result of your audit, you are to provide the

answers to the following:

1. How much is the gain on sale of 12,500 Ces shares?

a. P112,500 c. P140,625

b. P281,250 d. P 0

2. How much is the gain or loss on sale of 2,500 Coo shares? a. P28,125 gain c. P28,125 loss

b. P10,227 gain d. P 0

3. How much is the gain or loss on conversion of 2,500 France preferred

stock into 15,000 common stock?

a. P 28,125 loss c. P46,875 loss

b. P129,375 gain d. P 0

4. How much is the total dividend income for the year 2006?

a. P 64,375 c. P 51,875

b. P101,375 d. P364,375

5. How much should be reported as unrealized gain on trading securities in the company’s income statement for the year 2006?

a. P 4,500 c. P59,250

b. P67,773 d. P 0

Suggested Solution:

Question No. 1

Sales proceeds (12,500 shares x P33.75) P421,875

Less CV of Ces shares sold (12.5/30 x P742,500) 309,375 Gain on sale of 12,500 Ces shares P112,500

107

Question No. 2


Less CV of Coo shares sold (P450,000 x 2,500/11,000*) 102,273

Gain on sale of 2,500 Coo shares P 10,227

* total number of shares after 10% stock dividends (10,000 x 1.1)

Question No. 3

Fair value of preferred stock (2,500 shares x P78.75) P196,875

Less CV of shares converted (P487,500 x 2.5/5) 243,750

Loss on conversion of 2,500 France preferred shares P 46,875

Question No. 4

From France (5,000 shares x P2.50 x 2) P25,000

From Ces [(30,000 - 12,500) x P2.25) 39,375

Total dividend income in 2006 P64,375

Question No. 5

Trading securities, 1/1/06 P1,680,000 CV of Ces shares sold (see no. 1) (309,375)

CV of Coo shares sold (see no. 2) (102,273)

CV of France preferred shares converted (see no. 3) (243,750)

Cost of 7,500 France common shares received (see no. 3) 196,875

Trading securities, 12/31/06 before mark-to-market 1,221,477

Fair value of trading securities, 12/31/06 (see below) 1,289,250

Unrealized gain on trading securities P 67,773

France Corp., preferred [(5,000 - 2,500) x P92.25] P 230,625

France Corp. – Common (7,500 x P42.75) 320,625

Ces, Inc., common [(30,000 - 12,500) x P22.50] 393,750

Coo Co., common {[(10,000 x 1.1) - 2,500] x P40.50} 344,250

Fair value of trading securities, 12/31/06 P1,289,250

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

PROBLEM NO. 3

You were able to obtain the following ledger details of Trading Securities in

connection with your audit of the Bocaue Corporation for the year ended

December 31, 2006:

108

Particulars Date Ref. DR CR

Purchase of GOOD Co. –

4,000 shares

1-14 CV P 960,000

Purchase of LUCK Co. –

4,800 shares

2-20

CV

1,200,000

Sale of LUCK Co. – 1,600 shares

3-01 CR 360,000

Receipt of GOOD Stock Dividend

– Offsetting Credit to retained

earnings

5-31

JV

88,000

Sale of GOOD Stocks –

3,200 shares

8-15

CR

784,000

Sale of GOOD Stocks –

800 shares

10-1

CR

184,000

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

Kind Declared Record Payment Rate

Cash

Stock

Cash

01-02

05-02

08-01

01-15

05-15

08-30

01-31

05-31

09-15

P20/share

10%

P30/share

At December 31, 2006, GOOD and LUCK shares were selling at P210 and

P240 per share, respectively.

QUESTIONS:


1. Gain or loss on sale of 1,600 LUCK shares on March 1, 2006

a. P360,000 gain c. P40,000 loss

b. P200,000 loss d. P40,000 gain

2. Gain on sale of 3,200 GOOD shares on August 15, 2006

a. P 48,000 c. P16,000

b. P144,000 d. P 0

3. Gain or loss on sale of 800 GOOD shares on October 1, 2006

a. P 8,000 gain c. P 8,000 loss

b. P24,000 loss d. P24,000 gain

4. Dividend income for the year 2006

a. P132,000 c. P212,000

b. P300,000 d. P 0

109

5. Carrying value of Trading Securities as of December 31, 2006

a. P768,000 c. P880,000

b. P852,000 d. P768,000

Suggested Solution:

Question No. 1

Sales proceeds P360,000

Less CV of shares sold (P1,200,000 x 1,600/4,800) 400,000

Loss on sale of 1,600 Luck shares on 3/1/06 P 40,000

Question No. 2

Total proceeds P784,000

Less dividends sold (3,200 shares x P30) 96,000 Sales proceeds 688,000

Less CV of investment sold

(P880,000* x 3,200/4,400**)

640,000

Gain on sale of 3,200 Good shares on 9/15/06 P 48,000

Computation of adjusted cost of Good Co. shares

Total cash paid P960,000

Less purchased dividend (4,000 x P20) 80,000

Adjusted cost P880,000 *

**After 10% stock dividend

Question No. 3


Less CV of investment sold (P880,000 x 800/4,400) 160,000

Gain on sale of 800 Good shares on 10/1/06 P 24,000

Question No. 4

Dividend income - Declared Aug. 1 (4,400 shares x P30) P132,000

Question No. 5

Good Co. [(4,000 x 1.1) - 3,200 - 800] = 400 x P210 P 84,000

Luck Co. (4,800 - 1,600) = 3,200 x P240 768,000

Carrying value of trading securities, 12/31/06 P852,000

Answers: 1) C; 2) A; 3) D; 4) A, 5) B

110

PROBLEM NO. 4

In connection with your audit of the financial statements of the Guiguinto

Company for the year 2006, the following Available for Sale Securities and

Dividend Income accounts were presented to you:

Available for Sale Securities Date Description Ref. Debit Credit

01/08

03/30

04/03

12/02

Purchased 20,000 shares

common, par value P50,

BUSTOS Co.

10,000 shares BUSTOS Co.

received as stock dividend

Sold 10,000 shares @ P25

Sold 4,000 shares @ P60

VR-69

CJ-30

CR-44

CR-65

780,000

500,000

250,000

240,000

Dividend Income

Date Description Ref. Debit Credit

03/30

08/30

Stock dividend

BUSTOS Company common

SJ-8

CR-52

500,000

100,000

The following information was obtained during your examination:

1. From independent sources, you determine the following dividend

information:

Type of

Dividend

Date

Declared

Date of

Record

Date of

Payment

Rate

Stock

Cash

Cash

02/14/2006

08/01/2006

12/01/2006

02/28/2006

08/15/2006

12/15/2006

03/30/2006

08/30/2006

01/02/2007

50%

P5/share

20%

2. Closing market quotation as at December 31, 2006:

Bid Asked

BUSTOS Company common 13-3/4 16-1/2

QUESTIONS:

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

1. How much is the gain or loss on the April 3, 2006 sale?

a. P10,000 loss c. P140,000 loss

b. P10,000 gain d. P 0

2. How much is the gain on the December 2, 2006 sale?

a. P136,000 c. P84,000 b. P 96,000 d. P 0

111

3. How much is the total dividend income for the year 2006?

a. P600,000 c. P100,000

b. P800,000 d. P300,000

4. How much is the adjusted balance of Available for Sale Securities as of

December 31, 2006? a. P290,000 c. P220,000

b. P264,000 d. P416,000

5. How much is the Unrealized Loss on AFS as of December 31, 2006?

a. P196,000 c. P152,000

b. P 70,000 d. P 0

Suggested Solution:

Question No. 1


Less CV of investment sold (P780,000 x 10/30*) 260,000

Loss on sale of AFS on 4/3/06 P 10,000

*After 50% stock dividend

Question No. 2

Total proceeds (4,000 shares x P60) P240,000

Less dividends sold (4,000 shares x P50 x 20%) 40,000

Net sales proceeds 200,000 Less CV of investment sold (P780,000 x 4/30) 104,000

Gain on sale of AFS on 12/2/06 P 96,000

Question No. 3

Cash dividends declared, 8/1/2006

(20,000 shares x P5)

P100,000

Cash dividends declared, 12/1/2006

(20,000 shares x P50 x 20%)

200,000

Total dividend income P300,000

Question No. 4

Shares purchased, 1/08 20,000

Shares received as stock dividend 10,000

Sold, 4/3 (10,000)

Sold, 12/2 (4,000)

Balance, 12/31/06 16,000

Multiply by market value/share, 12/31/06 13.75

Carrying value of AFS, 12/31/06 P220,000

112

Note: Application guidance par. 72 of PAS 39 states that the appropriate market price for an asset held or liability to be issued is usually the current bid price and, for an asset to be acquired or liability held, the asking price.

Question No. 5

Acquisition cost P780,000

CV of 10,000 shares sold, 4/3 (see no. 1) (260,000)

CV of 4,000 shares sold, 12/2 (see no. 2) (104,000)

AFS, 12/31/06 before mark-to-market 416,000

Fair value of AFS, 12/31/06 220,000

Unrealized loss on AFS, 12/31/06 P196,000

Answers: 1) A; 2) B; 3) D; 4) C, 5) A

PROBLEM NO. 5

Your audit of the Baliuag Corporation disclosed that the company owned

the following securities on December 31, 2005:

Trading securities:

Security Shares Cost Market

Sputnik, Inc. 4,800 P 72,000 P 92,000

Explorer, Inc. 8,000 216,000 144,000

10% , P100,000 face value , Vanguard bonds (interest payable

semiannually on Jan. 1 and Jul. 1)

79,200

81,720

Total P367,200 P317,720

Available-for-sale securities:

Security Shares Cost Market

Score Products 16,000 P 688,000 P 720,000

Tiros, Inc. 120,000 3,120,000 2,920,000

Midas, Inc. 40,000 480,000 640,000 Total P4,288,000 P4,280,000

Held to maturity:

Cost Book value

12%, 1,000,000 face value, Discoverer bonds

(interest payable annually every Dec. 31)

P950,000

P963,000

113

During 2006, the following transactions occurred:

Jan. 1 Receive interest on the Vanguard bonds.

Mar. 1 Sold 4,000 shares of Explorer Inc. stock for P76,000.

May 15 Sold 1,600 shares of Midas, Inc. for P15 per share.

July 1 Received interest on the Vanguard bonds.

Dec. 31 Received interest on the Discoverer bonds.

31 Transferred the Discoverer bonds to the available-for-sale

portfolio. The bonds were selling at 101 on this date. The

bonds were purchased on January 2, 2005. The discount was

amortized using the effective interest method.

The market values of the stocks and bonds on December 31, 2006, are as

follows:

Sputnik, Inc. P22 per share

Explorer, Inc. P15 per share

10% Vanguard bonds P75,600

Score Products P42 per share

Tiros, Inc. P28 per share

Midas, Inc. P18 per share

QUESTIONS:


1. Gain or loss on sale of 4,000 Explorer, Inc. shares on March 1, 2006

a. P4,000 loss c. P32,000 loss

b. P4,000 gain d. P32,000 gain

2. Realized gain or loss on sale of 1,600 Midas, Inc. shares on May 15,

2006


b. P4,800 gain d. P1,600 gain

3. Total interest income for the year 2006?

a. P130,000 c. P144,820

b. P125,560 d. P143,000

4. The amount that should be reported as unrealized gain in the

statement of changes in equity regarding transfer of Discoverer bonds

to AFS?

a. P47,000 c. P61,820

b. P32,180 d. P 0

114

5. Carrying value of Trading Securities and Available-for-sale securities as

of December 31, 2006 should be

Trading securities Available-for-sale securities

a. P241,200 P5,733,200

b. P301,200 P4,723,200

c. P241,200 P5,762,000

d. P301,200 P5,720,800

Suggested Solution:

Question No. 1


Less CV of shares sold (P144,000 x 4/8) 72,000

Loss on sale of 4,000 Explorer, Inc. shares P 4,000

Question No. 2


Unrealized gain on the shares sold(P160,000 x 1.6/40) 6,400

Total 30,400

Less CV of shares sold (P640,000 x 1.6/40) 25,600

Realized gain on sale of 1,600 Midas, Inc. shares P 4,800

Alternative computation:


Cost of shares sold (P480,000 x 1.6/40) 19,200

Realized gain on sale of 1,600 Midas, Inc. shares P 4,800

Question No. 3

Vanguard bonds (P100,000 x 10%) P 10,000

Discoverer bonds (P963,000 x 14%*) 134,820

Total interest income for 2006 P144,820

*Computation of effective interest rate:

Carrying value, 12/31/05 P963,000

Less carrying value, 1/2/05 (Cost) 950,000

Discount amortization for 2005 13,000

Add nominal interest (P1,000,000 x 12%) 120,000

Effective interest 133,000

Divide by carrying value, 1/2/05 950,000

Effective interest rate 14%

115

Question No. 4

Carrying value, 12/31/05 P 963,000

Add discount amortization in 2006:

Effective interest (P963,000 x 14%) P134,820

Nominal interest (P1,000,000 x 12%) (120,000) 14, 820

Carrying value, 12/31/06 977,820 Fair value of Discoverer bonds on

12/31/06 (P1,000,000 x 1.01)

1,010,000

Unrealized gain on transfer of securities

to be reported under SHE

P 32,180

Question No. 5

Trading securities

Sputnik, Inc. (4,800 x P22) P105,600

Explorer, Inc. [(8,000 - 4,000) x P15] 60,000

10% , P100,000 face value , Vanguard bonds 75,600

Total market value P241,200

Available-for-sale securities

Score Products (16,000 x P42) P 672,000 Tiros, Inc. (120,000 x P28) 3,360,000

Midas, Inc. [(40,000 - 1,600) x P18] 691,200

Discoverer bonds (P1,000,000 x 1.01) 1,010,000

Total market value P5,733,200

Answers: 1) B; 2) B; 3) C; 4) B, 5) A

PROBLEM NO. 6

In connection with your audit of Hogonoy Company’s financial statements,

you were able to gather the following subsidiary account which reflect the

marketable securities of the company for the year 2006:

Hugo Corp.. Date Transactions Shares Debit Credit

9/01 Purchase

40,000 P2,000,000

9/30 Cash dividends to stockholders of record 9/15, declared 8/15

P 100,000

10/01 Purchase

100,000 5,000,000

10/15 Sale at P65

40,000 2,000,000

116

Hugo Corp.. Date Transactions Shares Debit Credit

11/30 Cash collected for sale made on 11/10, after a 11/1 declaration of P5 cash dividend per share to stockholders on record as of 12/1

40,000

6,600,000

12/15 Cash dividend received . 300,000

Totals P7,000,000 P9,000,000

Hogonoy, Inc. acquired 30% of Pugo Corporation’s voting stock on January

1, 2005 for P5,000,000. During 2005, Pugo earned P2,000,000 and paid

dividends of P1,250,000. Hogonoy’s 30% interest in Pugo gives Hogonoy

the ability to exercise significant influence over Pugo’s operating and

financial policies. During 2006, Pugo earned P2,500,000 and paid

dividends of P750,000 on April 1 and P750,000 on October 1. On July 1,

2006, Hogonoy sold half of its investment in Pugo for P3,300,000 cash.

QUESTIONS:


1. The gain on sale of 40,000 shares of Hugo Corp. on October 15 is

a. P628,600 c. P 600,000

b. P700,000 d. P2,057,000

2. The gain on sale of 40,000 shares of Hugo Corp. on November 10 is

a. P4,400,000 c. P2,000,000

b. P4,800,000 d. P4,600,000

3. The carrying value of the Company’s investment in Hugo Corp. on

December 31, 2006 is a. P2,700,000 c. P2,400,000

b. P2,000,000 d. P3,000,000

4. The gain on sale of investment in Pugo Corp. is

a. P1,312,500 c. P687,500

b. P 537,500 d. P612,500

5. The carrying value of the Company’s investment in Pugo Corp. on

December 31, 2006 is

a. P2,612,500 c. P2,687,500

b. P2,762,500 d. P1,987,500

117

Suggested Solution:

Question No. 1

Sales proceeds (40,000 shares x P65) P2,600,000

Less cost of investment sold:

Cash paid P2,000,000

Less purchased dividend 100,000 1,900,000

Gain on sale P 700,000

Question No. 2

Total proceeds P6,600,000 Less dividends sold (40,000 shares x P5) 200,000

Sales proceeds 6,400,000

Less cost of investment sold (P5,000,000 x 40/100) 2,000,000

Gain on sale of 40,000 shares of Hugo Corp., 11/10 P4,400,000

Question No. 3

Acquisition cost, 10/1 purchase P5,000,000

Less cost of investment sold on 11/10 (see no. 2) 2,000,000

Gain on sale of 3,200 Good shares on 9/15/06 P3,000,000

Question No. 4

Proceeds on sale of investment P3,300,000

Less carrying amount of investment sold:

Acquisition cost, 1/1/05 P5,000,000 Share in net income for 2005

(P2,000,000 x 30%)

600,000

Dividends received in 2005

(P1,250,000 x 30%)

(375,000)

Carrying value, 12/31/05 5,225,000

Share in net income up to 7/1/06

(P2,500,000 x 6/12 x 30%)

375,000

Dividends received up to 7/1/06

(P750,000 x 30%)

(225,000)

Carrying value, 7/1/06 5,375,000

Multiply by 1/2 2,687,500

Gain on sale P 612,500

Question No. 5

Carrying value, 7/1/06 P5,375,000 Less carrying amount of investment sold (see no. 4) 2,687,500

Gain on sale of 3,200 Good shares on 9/15/06 P2,687,500

118

Note: Since the client's equity was reduced to 15%, it was assumed that the client lost its ability to exercise significant influence. Thus, the investment will be accounted for using cost method from 7/1/06. Change from equity to cost method is accounted for currently and prospectively.

Answers: 1) B; 2) A; 3) D; 4) D, 5) C

PROBLEM NO. 7

The Marilao Company has the following transactions in the stocks of the

Sta. Maria Corp.

a) On January 2, 1999, Marilao purchased 4,000 shares of P100 par

value common stock at P110 per share.

b) The Sta. Maria Corp. was expanding and on March 2, 2000, it issued

stock rights to its stockholders. The holder needs four rights to

purchase one share of common stock at par. The market value of the

stock on that date was P140 per share. There was no quoted price for

the rights. No journal entry was made to record the receipt of the

rights.

c) On April 2, 2000, Marilao exercised all its stock rights. The Investment

in Stock account was charged for the amount paid.

d) Robinson, Marilao’s accountant, felt that the cash paid for the new

shares was merely an assessment since Marilao’s proportionate share

in Sta. Maria was not changed. Hence, he credited all dividends (5% in

December of each year) to the Investment in Stock account until the

debit was fully offset.

e) Marilao received a 50% stock dividend from Sta. Maria in December

2004. Because the shares received were expected to be sold, the

company’s president instructed Robinson not to make any entry for

this dividend. The company did sell the dividend shares in January

2005 for P150 per share. The proceeds from the sale were credited to

income.

f) In December 2005, Sta. Maria’ stocks were split on a two-for-one basis

and the new shares were issued as no par shares. Marilao found that

each new share was worth P10 more than the P110 per share original

acquisition cost. For this reason, Marilao decided to debit the

Investment in Stock account with the additional shares received at

P110 per share and credited revenue for it.

119

g) In August 2006, Marilao sold one half (½) of its holdings in Sta. Maria

at P120 per share. The proceeds were credited to the Investment in

Stock account.

Marilao uses the average method in recording the sale of its investment in

stock.

QUESTIONS:

1. The cost of investment to be allocated to stock rights received on March

2, 2000 is

a. P 0 c. P31,429

b. P29,333 d. P25,143

2. The unadjusted balance of Investment in Sta. Maria stock on December

31, 2006 is

a. P940,000 c. P390,000

b. P490,000 d. P430,000

3. The adjusted balance of Investment in Sta. Maria stock on December

31, 2006 is a. P135,000 c. P180,000

b. P360,000 d. P270,000

4. The gain on the sale of stock dividend received in December 2004 is

a. P100,000 c. P 80,000

b. P105,000 d. P195,000

5. The gain on sale of the shares sold in August 2006 is

a. P240,000 c. P120,000

b. P420,000 d. P870,000

Suggested Solution:

Question No. 1

Cost allocated to stock rights (P10*/P150 x P440,000) P29,333

Since the MV of rights is not available we must compute for the theoretical value of the stock rights. Since the market value of the stock given is on the date of issuance of the stock rights, the market value is considered “ex-rights”.

Theoretical value of stock rights = MV of stock ex-rights – subs. price Number of rights to purchase 1 share

= (P 140 - P100)/4

= P10*

120

Question No. 2

Debits to Investment account:

Purchase, 1/2/99 (4,000 shares x P110) P440,000

Exercise of rights, 4/2/00 (4,000/4 x P100) 100,000

Stock split, 12/2005 (5,000 x P110) 550,000 P1,090,000

Less credits to Investment account:

Dividends received, 2000-2003 (5,000 x P100 x 5% x 4)

100,000

Sale, 8/2006 (5,000 shares x P120) 600,000 700,000

Balance, 12/31/06 per books P 390,000

Question No. 3

Shares

Cost/

share

Total cost

Purchase, 1/2/1999 4,000 P110 P440,000

Receipt of stock rights, 3/2/2000 (29,333)

Balance 4,000 103 410,667

Exercise of rights, 4/2/2000 (see below) 1,000 129 129,333

Balance 5,000 108 540,000

50% stock dividend, 12/2004 2,500

Balance 7,500 72 540,000 Sale of stock dividend, 1/2005 (2,500) 72 (180,000)

Balance 5,000 72 360,000

Stock split, 12/2005 5,000

Balance 10,000 36 360,000

Sale, 8/2006 (5,000) 36 (180,000)

Adjusted balance, 12/31/06 5,000 36 P180,000

Cash paid (4,000/5 x P100) P 80,000

Cost of stock rights 29,333

Total cost P129,333

Question No. 4


Less cost of investment sold (see no. 3) 180,000

Gain on sale of stock dividend received P195,000

Question No. 5


Less cost of investment sold (see no. 3) 180,000

Gain on sale of investment in 8/2006 P420,000

121

Answers: 1) B; 2) C; 3) C; 4) D, 5) B

PROBLEM NO. 8

Meycauayan Inc. acquired 50,000 shares of AAA stock for P5 per share and

125,000 shares of BBB stock for P10 per share on January 2, 2005. Both

AAA Inc. and BBB Corp. have 500,000 shares of no-par common stock outstanding. Both securities are being held as long term investments.

Changes in retained earnings for AAA and BBB for 2005 and 2006 are as

follows:

AAA, Inc. BBB Corp.

Retained earnings (deficit), 1/1/05 P1,000,000 (P175,000)

Cash dividends, 2005 (125,000) -

Net income, 2005 200,000 325,000

Retained earnings, December 31, 2005 1,075,000 150,000

Cash dividends, 2006 (150,000) (50,000)

Net income, 2006 300,000 125,000

Retained earnings, December 31, 2006 P1,225,000 P 225,000

Market value of stock: 12/31/05 P7.00 P12.00

12/31/06 6.50 15.00

QUESTIONS:


1. The income from investment in AAA, Inc. in 2006 is

a. P15,000 c. P12,500

b. P 1,000 d. P 0

2. The income from investment in BBB, Inc. in 2005 is

a. P31,250 c. P2,500 b. P81,250 d. P 0

3. The carrying value of Investment in AAA, Inc. as December 31, 2006 is

a. P250,000 c. P325,000

b. P350,000 d. P252,500

4. The carrying value of Investment in BBB, Inc. as December 31, 2006 is

a. P1,250,000 c. P1,875,000

b. P1,268,750 d. P1,350,000

5. How much is the unrealized gain or loss that will be included as

component of equity as of December 31, 2006?

a. P75,000 gain c. P25,000 gain b. P25,000 loss d. P 0

122

Suggested Solution:

Question No. 1

Meycauayan, Inc. owns 10% (50,000/500,000) of AAA, Inc. stock; therefore, the cost method is used and the dividend is computed as follows:

Dividends paid by AAA, Inc. in 2006 P150,000

Multiply by % ownership 10%

Income from investment in AAA, Inc. in 2006 P 15,000

Question No. 2

Meycauayan, Inc. owns 25% (125,000/500,000) of BBB Corp. stock;

therefore, the equity method is used to record the income earned.

AAA, Inc. net income in 2005 P325,000

Multiply by % ownership 25%

Income from investment in BBB Corp. in 2005 P 81,250

Question No. 3

Investment in AAA, Inc. stock will be classified as available-for-sale securities since the shares are held as long term investment and there is reliable fair value. Therefore, the carrying value as of 12/31/06 is P325,000 (50,000 shares x P6.50).

Question No. 4

Acquisition cost (125,000 shares x P10) P1,250,000

Share in net income for 2005 (P325,000 x 25%) 81,250

Carrying value, 12/31/05 1,331,250

Dividends received in 2006 (P50,000 x 25%) (12,500)

Share in net income for 2006 (P125,000 x 25%) 31,250

Carrying value, 12/31/06 P1,350,000

Question No. 5

Fair value, 12/31/06 (50,000 shares x P6.50) P 325,000

Acquisition cost (50,000 shares x P5) 250,000

Unrealized gain, 12/31/06 P 75,000

Answers: 1) A; 2) B; 3) C; 4) D, 5) A

123

PROBLEM NO. 9

On January 2, 2004, Norzagaray Company acquired 20% of the 400,000

shares of outstanding common stock of Imaw Corporation for P30 per

share. The purchase price was equal to Imaw’s underlying book value.

Norzagaray plans to hold this stock to influence the activities of Imaw.

The following data are applicable for 2004 and 2005:

2004 2005

Imaw dividends (paid Oct. 31) P 40,000 P 48,000

Imaw earnings 140,000 160,000

Imaw stock market price at year-end 32 31

On January 2, 2006, Norzagaray Company sold 20,000 shares of Imaw

stock for P31 per share. During 2006, Imaw reported net income of

P120,000, and on October 31, 2006, Imaw paid dividends of P20,000. At

December 31, 2006, after a significant stock decline, which is expected to

be temporary, Imaw’s stock was selling for P22 per share. After selling the

20,000 shares, Norzagaray does not expect to exercise significant influence over Imaw, and the shares are classified as available for sale.

QUESTIONS:


1. Carrying value of Investment in Imaw as of December 31, 2004

a. P12,020,000 c. P2,420,000

b. P 2,500,000 d. P2,388,000

2. Carrying value of Investment in Imaw as of December 31, 2005

a. P2,442,400 c. P12,042,400

b. P2,612,000 d. P 2,372,000

3. Gain or loss on sale of Investment in Imaw on January 2, 2006

a. P2,390,600 loss c. P33,000 loss

b. P 9,400 gain d. P27,000 gain

4. The income from investment in BBB, Inc. in 2005 is

a. P 3,000 c. P4,000

b. P24,000 d. P 0

5. Net unrealized loss on available for sale securities as of December 31,

2006

a. P671,800 c. P639,000

b. P511,800 d. P459,000

124

Suggested Solution:

Question No. 1

Acquisition cost (400,000 x 20% x P30) P2,400,000

Dividends received(P40,000 x 20%) (8,000)

Investment income (P140,000 x 20%) 28,000


Question No. 2

Carrying value, 12/31/04 (see no. 1) P2,420,000

Dividends received (P48,000 x 20%) (9,600)

Investment income (P160,000 x 20%) 32,000


Question No. 3

Sales proceeds (20,000 x P31) P620,000

Less carrying value of investment sold (P2,442,400 x 20/80)

610,600

Gain on sale of investment P 9,400

Question No. 4

Dividend income (P20,000 x 15%*) P3,000

* [20% - (20,000/400,000 x 100%)]

Question No. 5


Less carrying value of investment sold 610,600

Carrying value, 12/31/06 - before reclassification 1,831,800

Fair value of AFS, 12/31/06 [(80,000 - 20,000) x P22] 1,320,000

Unrealized loss on AFS P 511,800

Answers: 1) C; 2) A; 3) B; 4) A, 5) B

PROBLEM NO. 10

You were able to gather the following in connection with your audit of

Obando, Inc. On December 31, 2005, Obando reported the following

available for sale securities:

125

Cost

Market

Unrealized

loss

ERAP Corp., 10,000 shares

of common stock

(a 1% interest)

P 250,000

P 220,000

P 30,000

GMA Corp., 20,000 shares

of common stock (a 2% interest)

320,000

300,000

20,000

FVR Corp., 50,000 shares of

common stock

(a 10% interest)

1,400,000

1,350,000

50,000

Total P1,970,000 P1,870,000 P100,000

Additional information:

On April 1, 2006, ERAP issued 10% stock dividend when the market

price of its stock was P24 per share.

On September 15, 2006, ERAP paid cash dividend of P0.75 per share.

On August 30, 2006, GMA issued to all shareholders, stock rights on

the basis of one right per share. Market prices at date of issue were

P13.50 per share of stock and P1.50 per right. Obando sold all rights

on December 1, 2006 for net proceeds of P37,600.

On July 1, 2006, Obando paid P3,040,000 for 100,000 additional

shares of FVR Corp.’s common stock which represented a 20%

investment in FVR. The fair value of all of FVR’s identifiable assets net of liabilities was equal to their carrying amount of P12,700,000. As a

result of this transaction, Obando owns 30% of FVR and can exercise

significant influence over FVR’s operating and financial policies.

Obando’s initial 10% interest of 50,000 shares of FVR’s common stock was acquired on January 2, 2005 for P1,400,000. At that date, the net

assets of FVR totaled P11,600,000 and the fair values of FVR‘s

identifiable assets net liabilities were equal to their carrying amount.

Market prices per share of the securities which are all listed in the

Philippine Stock Exchange, are as follows:

12/31/2006 12/31/2005

ERAP Corp. – common P23 P22

GMA Corp. – common 14 15

FVR Corp. – common 31 27

126

FVR reported net income and paid dividends of:

Net income

Dividend

per share

Year ended December 31, 2005 P700,000 None

Six months ended June 30, 2006 400,000 None Six months ended December 31, 2006

(dividend was paid on 10/1/2006)

740,000

P1.30

There were no other intercompany transactions between Obando and FVR.

QUESTIONS:


1. Net unrealized gain or loss on available for sale securities as of

December 31, 2006

a. P95,000 gain c. P 5,000 loss

b. P37,000 loss d. P55,000 loss

2. Net adjustment to Retained Earnings as of January 1, 2006 as a result

of the purchase of additional shares of stock of FVR Corp.

a. P 70,000 c. P58,000

b. P210,000 d. P 0

3. Net investment income from FVR Corp. for year ended December 31,

2006 a. P237,500 c. P262,000

b. P225,000 d. P305,000

4. Carrying amount of Investment in FVR Corp. as of December 31, 2006

a. P4,674,500 c. P4,577,000

b. P4,677,000 d. P4,540,500

5. Gain on sale of stock rights on December 1, 2006

a. P 0 c. P7,600

b. P2,050 d. P5,600

Suggested Solution:

Question No. 1

Available-for-sale securities, 1/1/06 P 1,870,000

Receipt of stock rights from GMA, 8/30 (P300,000 x 1.5/15)

(30,000)

Reclassification of Investment in FVR (1,350,000)

AFS, 12/31/06 before mark-to-market 490,000

127

Fair value of AFS, 12/31/06:

GMA [(10,000 x 1.1) x 23] P253,000

ERAP (20,000 x 14) 280,000 533,000

Decrease in unrealized loss on AFS 43,000

Unrealized loss on AFS, 12/31/05 (P100,000 - P2,000 - P50,000)

(see note below)

48,000 Unrealized loss, 12/31/06 - as adjusted P 5,000

Note: Alternatively, the unrealized loss on AFS can be computed by comparing the total fair value and total cost of AFS as of December 31, 2006. Incidentally, the journal entries to record the receipt of stock rights and reclassification of the investment in FVR follow:

Stock rights P 32,000

Available for sale securities (P300,000 x 1.5/15) P30,000

Unrealized loss on AFS (P20,000 x 1.5/15) 2,000

Investment in associate P1,400,000

Available for sale securities P1,350,000

Unrealized loss on AFS 50,000

Questions No. 2 to 4

Reclassification of investment in FVR (see no. 1) P1,400,000

Retroactive adjustment

(cost to equity method):

Share in NI for 2005 (P700,000 x 10%) 70,000 (2)

Adjusted balance, 1/1/06 1,470,000

Cost of additional 100,000 shares 3,040,000

Net investment income for 2006:

Share in NI for six months ended 6/30

(P400,000 x 10%)

P40,000

Share in NI for six months ended

12/31 [P740,000 x (10%+20%)]

222,000

262,000

(3)

Dividends received [(50,000 shares + 100,000 shares) x 1.3]

(195,000)

Carrying value of investment in FVR, 12/31/06 P 4,577,000 (4)

Note: The excess of cost over the book value of net assets acquired will be attributed to Goodwill. Therefore, the excess will not affect the investment income and the carrying value of the investment since Goodwill is not amortized.

128

Question No. 5


Less cost of stock rights (see no. 1) 32,000

Gain on sale of stock rights P 5,600

Answers: 1) C; 2) A; 3) C; 4) C, 5) D

PROBLEM NO. 11

Paombong Corporation purchased P200,000 8% bonds for P184,557 on

January 1, 2004. Paombong classified the bonds as available for sale. The

bonds were purchased to yield 10% interest. Interest is payable

semiannually on July 1 and January 1. The bonds mature on January 1,

2009. Paombong uses the effective interest method to amortize premium or

discount. On January 2, 2006, Paombong sold the bonds for P185,000

after receiving interest to meet its liquidity needs.

The market values of the bonds are as follows:

December 31, 2004 P190,449

December 31, 2005 186,363

QUESTIONS:


1. Interest income for the year 2004 a. P14,869 c. P18,517

b. P16,000 d. P18,456

2. Unrealized gain on AFS as of December 31, 2004

a. P3,436 c. P5,892

b. P3,375 d. P 0

3. Interest income for the year 2005

a. P18,775 c. P16,000

b. P15,272 d. P18,701

4. Unrealized gain or loss on AFS as of December 31, 2005

a. P8,053 gain c. P3,351 gain b. P3,486 loss d. P1,806 loss

5. Realized gain or loss on sale of AFS on January 2, 2006


b. P4,714 loss d. P9,416 gain

129

Suggested Solution:

Question No. 1

The following amortization schedule will be useful in computing for the requirements:

Date

Effective

interest

Nominal

interest

Discount

amortization

Carrying

value

01/01/04 P184,557

07/01/04 P9,228 P8,000 P1,228 185,785 12/31/04 9,289 8,000 1,289 187,074

07/01/05 9,354 8,000 1,354 188,428

12/31/05 9,421 8,000 1,421 189,849

07/01/06 9,492 8,000 1,492 191,341

12/31/06 9,567 8,000 1,567 192,908

07/01/07 9,645 8,000 1,645 194,553

12/31/07 9,728 8,000 1,728 196,281

07/01/08 9,814 8,000 1,814 198,095

12/31/08 9,905 8,000 1,905 200,000

1/1/04 to 6/30/04 (see amortization schedule) P 9,228

7/1/04 to 12/31/04 (see amortization schedule) 9,289


Note: PAS 39 par. 55(b) states that a gain or loss on an available-for-sale financial asset shall be recognized directly in equity, through the statement of changes in equity, except for impairment losses and foreign exchange gains and losses, until the financial asset is derecognized, at which time the cumulative gain or loss previously recognized in equity shall be recognized in profit or loss. However, interest calculated using effective interest method shall be recognized in profit or

loss.

Question No. 2

Fair value the bonds, 12/31/04 P190,449

Carrying value, 12/31/04 (see amortization schedule) 187,074

Unrealized gain on AFS, 12/31/04 P 3,375

Question No. 3

1/1/05 to 6/30/05 (see amortization schedule) P 9,354

7/1/05 to 12/31/0 (see amortization schedule) 9,421


130

Question No. 4

Fair value the bonds, 12/31/05 P186,363

Carrying value, 12/31/05 (see amortization schedule) 189,849

Unrealized loss on AFS, 12/31/05 (P 3,486)

Incidentally, the adjusting entry on 12/31/05 follows:

Unrealized gain on AFS P 3,375


Available for sale securities P6,861

Question No. 5


Unrealized loss on AFS ( 3,486)

Net 181,514

Carrying value, 12/31/05 (fair value) 186,363

Realized loss on sale of AFS (P 4,849)

Note: PAS 39 par. 26 states that on derecognition of a financial asset in its entirety, the difference between (a) the carrying amount and (b) the sum of the consideration received and any cumulative gain or loss recognized directly in equity, shall be recognized in profit or loss. Incidentally, the journal entry to record the sale is:

Cash P185,000

Realized loss on sale of AFS 4,849

Available for sale securities P186,363


Answers: 1) C; 2) B; 3) A; 4) B, 5) C

PROBLEM NO. 12

On June 1, 2005, Pandi Corporation purchased as a long term investment

4,000 of the P1,000 face value, 8% bonds of Violet Corporation. 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, 2011. Pandi uses

the effective interest method of amortization. On November 1, 2006, Pandi

sold the bonds for a total consideration of P3,925,000. Pandi intended to

hold these bonds until they matured, so year-to-year market fluctuations

were ignored in accounting for bonds.

131

QUESTIONS:


(Round off present value factors to four decimal places)

1. The purchase price of the bonds on June 1, 2005 is

a. P3,645,328 c. P3,696,736 b. P3,691,132 d. P3,624,596

2. The interest income for the year 2005 is

a. P215,850 c. P212,829

b. P215,521 d. P211,612

3. The carrying value of the investment in bonds as of December 31, 2005

is

a. P3,725,919 c. P3,719,986

b. P3,649,541 d. P3,671,490

4. The interest income for the year 2006 is

a. P306,607 c. P311,218 b. P310,715 d. P304,748

5. The gain on sale of investment in bonds on November 1, 2006 is

a. P21,196 c. P 27,632

b. P80,235 d. P104,045

Suggested Solution:

Question No. 1

PV of principal (P4,000,000 x 0.5568) P2,227,200

PV of interest [(P4,000,000 x 4%) x 8.8633] 1,418,128

Purchase price P3,645,328

Question No. 2

June 1 to Nov. 30 (P3,645,328 x 10% x 6/12) P182,266

Dec. 1 to Dec. 31 (P3,667,594a x 10% x 1/12) 30,563


a Computation of carrying value,12/1/05:


Add discount amortization,

6/1/05 to 11/30/05:

Effective interest (P3,645,468 x 10% x 6/12) P182,266

Nominal interest (P4,000,000 x 8% x 6/12) 160,000 22,266


132

Question No. 3



12/1/05 to 12/31/05:


Nominal interest (P4,000,000 x 8% x 1/12) 26,667 3,896 Carrying value, 12/31/05 P3,671,490

Question No. 4

Jan. 1 to May 31 (P3,667,594 x 10% x 5/12) P152,816

June 1 to Nov. 1 (P3,690,974b x 10% x 5/12) 153,791


b Computation of carrying value,6/1/06:



12/1/05 to 5/31/06


Nominal interest (P4,000,000 x 8% x 6/12) 160,000 23,380


Question No. 5

Total proceeds P3,925,000 Less accrued interest (P4,000,000 x 8% x 5/12) 133,333

Sales proceeds 3,791,667

Less carrying value, 11/1/06 (see below) 3,711,432

Gain on sale on investment in bonds P 80,235

Computation of carrying value,11/1/06:



6/1/06 to 11/1/06

Effective interest (P3,690,974 x 10% x 5/12) P153,791 Nominal interest (P4,000,000 x 8% x 5/12) 133,333 20,468


Answers: 1) A; 2) C; 3) D; 4) A, 5) B

133

PROBLEM NO. 13

On May 1, 2003, Plaridel Corporation acquired P1,600,000 of J & B

Corporation 9% bonds at 97 plus accrued interest. Interest on bonds is

payable semiannually on March 1 and September 1, and bonds mature on

September 1, 2006. Plaridel intends to hold these bonds until they

matured.

Due to an isolated event that is beyond Plaridel’s control, is non-recurring

and could not have been reasonably anticipated by Plaridel, the company

sold bonds of P480,000 for 103 plus accrued interest on May 1, 2004.

On July 1, 2005, bonds of P640,000 were exchanged for 90,000 shares of J

& B Corporation, common, no par value, quoted on the market on this date

at P8 per share. Interest was received on bonds to date of exchange.

On September 1, 2006, remaining bonds were redeemed and accrued

interest was received.

QUESTIONS:


(Use the straight line amortization method)

1. Total interest income for 2003 is

a. P96,000 c. P105,600

b. P86,400 d. P106,800

2. The carrying value of the investment in bonds as of December 31, 2003

is

a. P1,561,600 c. P1,562,800

b. P1,540,000 d. P1,564,000

3. The gain on sale of the bonds on May 1, 2004 is a. P 0 c. P 2,880

b. P4,320 d. P24,480

4. The gain on exchange the bonds on July 1, 2005 is

a. P 0 c. P57,920

b. P86,720 d. P73,280

5. Total cash received by the company on September 1, 2006 is

a. P501,600 c. P480,000

b. P523,200 d. P508,800

134

Suggested Solution:

Question No. 1

Nominal interest (P1,600,000 x 9% x 8/12) P 96,000

Discount amortization for 2003 (P48,000 x 8/40) 9,600


Question No. 2

Carrying value, 5/1/03 (P1,600,000 x 97%) P1,552,000 Add discount amortization for 2003 (see no. 1) 9,600


Question No. 3

Selling price (P480,000 x 1.03) P494,400

Less carrying value of bonds sold:

Face value P480,000

Less unamortized bond discount, 5/1/04

to 9/1/06 (P48,000 x 480/1,600 x 28/40)

10,080

469,920

Gain on sale of investment in bonds P 24,480

PAS 39 par. 52 states that whenever sales or reclassifications of more than an insignificant amount of held-to-maturity investments do not meet any of the conditions in par. 9, any remaining held-to-maturity investments shall be reclassified as available for sale. Since the sale of the bonds on May 1, 2004 is due to an isolated event that is beyond Plaridel’s control, is non-recurring and could not have been reasonably anticipated by Plaridel, the investment is not required to be reclassified as available for sale.

Question No. 4

Fair value of stocks received (P90,000 x P8) P720,000

Less carrying value of bonds exchanged:

Face value P640,000

Less unamortized bond discount, 7/1/05 to 9/1/06 (P48,000 x 640/1,600 x 14/40)

6,720

633,280

Gain on exchange of bonds P 86,720

Question No. 5

Face value of remaining bonds (P1,600,000 - P480,000 - P640,000)

P480,000

Interest, 3/1/06 to 9/1/06 (P480,000 x 9% x 6/12) 21,600

Total cash received, 9/1/06 P501,600

Answers: 1) C; 2) A; 3) D; 4) B, 5) A

135

PROBLEM NO. 14

Pulilan Company’s accounting records showed the following investments at

January 1, 2006:

Common stock:

Jang Company (1,000 shares) P 500,000 Geum Company (5,000 shares) 5,000,000

Parking lot (leased to Jewel Company) 2,500,000

Trademark 2,000,000

Total investments P10,000,000

Additional information:

Pulilan owns 1% of Jang and 30% of Geum. During the year ended

December 31, 2006, Pulilan received cash dividends of P350,000 from

Jang and P750,000 from Geum, whose 2006 net earnings were

P4,000,000 and P10,000,000 respectively.

The Jewel lease which commenced on January 1, 2005 is for 5 years at

an annual rental of P1,250,000. In addition, on January 1, 2005,

Jewel paid a nonrefundable deposit of P400,000 as well as a security

deposit of P250,000, to be refunded upon expiration of lease. Pulilan

received P1,250,000 rent from Jewel in 2006.

The trademark was licensed to Palace Company for royalties of 10% of

sales of the trademark items. Royalties are payable semiannually on

March 1, for sales in July through December of the prior year, and on

September 1, for sales in January through June of same year. On

March 1, 2005 and 2006, Pulilan received royalties of P500,000 and

P750,000, respectively. On September 1, 2005 and 2006, Pulilan

received royalties of P1,000,000 and P1,500,000 respectively. Palace

Company’s sales of the trademarked items totaled P4,000,000 for the last half of 2006.

QUESTIONS:


1. Total income from investments in equity securities

a. P3,350,000 c. P4,100,000

b. P1,100,000 d. P3,000,000

2. Rent income for 2006

a. P1,250,000 c. P1,650,000

b. P1,330,000 d. P1,380,000

136

3. Royalty income for 2006

a. P1,500,000 c. P2,500,000

b. P2,000,000 d. P1,900,000

Suggested Solution:

Question No. 1

Dividend income from Jang P 350,000

Investment income from Geum (P10,000,000 x 30%) 3,000,000 Total income from investments in equity securities P3,350,000

Question No. 2

Annual rental P1,250,000

Amortization of lease bonus (P400,000/5) 80,000

Rent income for 2006 P1,330,000

Question No. 3

January to June 2006 P1,500,000

July to December 2006 (P4,000,000 x 10%) 400,000

Royalty income for 2006 P1,900,000

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

PROBLEM NO. 15

Select the best answer for each of the following:

1. Which of the following is not a control that is designed to protect

investment securities?

a. Access to securities should be vested in more than one individual.

b. Securities should be properly controlled physically in order to

prevent unauthorized usage.

c. Securities should be registered in the name of the owner.

d. Custody over securities should be limited to individuals who have recordkeeping responsibility over the securities.

2. Which of the following controls would a company most likely use to

safeguard investment securities when an independent trust agent is not

employed?

a. The chairman of the board verifies the investment securities, which

are kept in a bank safe deposit box, each year on the balance sheet

date.

137

b. The investment committee of the board of directors periodically

reviews the investment decisions delegated to the treasurer.

c. Two company officials have joint control of investment securities,

which are kept in a bank safe deposit box.

d. The internal auditor and the controller independently trace all

purchases and sales of investment securities from the subsidiary

ledgers to the general ledger.

3. Which of the following controls would an entity most likely use to assist

in satisfying the completeness assertion related to long-term

investments?

a. The controller compares the current market prices of recorded

investments with the brokers’ advices on file.

b. Senior management verifies that securities in the bank safe deposit

box are registered in the entity’s name.

c. The internal auditor compares the securities in the bank safe

deposit box with recorded investments.

d. The treasurer vouches the acquisition of securities by comparing

brokers’ advices with canceled checks.

4. Which of the following controls would an entity most likely use in safeguarding against the loss of investment securities?

a. A designated member of the board of directors controls the

securities in a bank safe deposit box.

b. An independent trust company that has no direct contact with the

employees who have record-keeping responsibilities has possession

of securities.

c. The internal auditor verifies the investment securities in the entity’s

safe each year on the balance sheet date.

d. The independent auditor traces all purchases and sales of

investment securities through the subsidiary ledgers to the general

ledger.

5. When negotiable securities are of considerable volume, planning by the

auditor is necessary to guard against a. Substitution of securities already counted for other securities which

should be on hand but are not.

b. Substitution of authentic securities with counterfeit securities.

c. Unauthorized negotiation of the securities before they are counted.

d. Unrecorded sales of securities after they are counted.

6. In auditing investments for proper valuation, the auditor should do all

but the following:

138

a. Vouch purchases and sales of securities by tracing to brokers'

advices and canceled checks.

b. Compare cost and market by reference to year end market values

for selected securities.

c. Confirm securities held in safekeeping off the client's premises.

d. Recalculate gain or loss on disposals.

7. An audit procedure that provides evidence about proper valuation of

trading securities arising from a short-term investment of excess cash

is

a. Recalculation of investment carrying value by applying the equity

method. b. Comparison of carrying value with current market quotations.

c. Confirmation of securities held by broker.

d. Calculation of premium or discount amortization.

8. The auditee has acquired another company by purchase. Which of the

following would be the best audit procedure to test the appropriateness

of the allocation of cost to tangible assets?

a. Evaluate procedures used to estimate and record fair market values

for purchased assets.

b. Determine whether assets have been recorded at their book value at

the date of purchase.

c. Evaluate the reasonableness of recorded values by discussion with

operating personnel.

d. Evaluate the reasonableness of recorded values by use of

replacement cost data.

9. The auditee has just acquired another company by purchasing all its assets. As a result of the purchase, "goodwill" has been recorded on

the auditee's books. Which of the following comparisons would be the

most appropriate audit test for the amount of recorded goodwill?

a. The purchase price and the fair market value of assets purchased.

b. The purchase price and the book value of assets purchased.

c. The figure for goodwill specified in the contract for purchase.

d. Earnings in excess of 15% of net assets for the past five years.

10. Of the following, which is the most efficient audit procedure for testing

accrued interest earned on bond investments?

a. Vouching the receipt and deposit of interest checks.

b. Tracing interest declarations to an independent record book.

c. Recomputing interest earned.

d. Confirming interest rate with the issuer of the bonds.

Answers: 1) D; 2) C; 3) C; 4) B, 5) A; 6) C; 7) B; 8) A; 9) A; 10) C

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