Auditing

Easy

1. Which of the following would be least likely to be considered an audit planning procedure?

a. Use an engagement letter.

b. Develop the overall audit strategy.
c. Perform risk assessment.
d. Develop the audit plan.

Answer: C

Performing the risk assessment occurs subsequent to audit planning.

2. A successor auditor should request the new client to authorize the predecessor auditor to allow a
review of the predecessors
Engagement letter Working papers
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer: C

The requirement is to determine whether a successor auditor should request a new client to authorize the
predecessor auditor to allow a review of the predecessors engagement letter, working papers, or both.
Answer c is correct because standard states that it is advisable that a successor auditor request to be
allowed to review the predecessors working papers.

3. Professional skepticism requires that an auditor assume that management is

a. Honest, in the absence of fraud risk factors.

b. Dishonest until completion of audit tests.
c. Neither honest nor dishonest.
d. Offering reasonable assurance of honesty

Answer: C

Professional skepticism requires that an auditor neither assume dishonesty nor unquestioned
honesty.

4. Which of the following most likely would not be considere an inherent limitation of the potential
effectiveness of an entitys internal control?

a. Incompatible duties.
b. Management override.
c. Mistakes in judgment.
d. Collusion among employees.

Answer: A

The requirement is to identify the reply that most likely would not be considered an inherent limitation of
the potential effectiveness of an entitys internal control. Answer A is correct because incompatible duties
may generally be divided among individuals in such a manner as to control the problem.
 5. Which of the following is not a component of an entitys internal control?

a. Control risk.
b. Control activities.
c. Monitoring.
d. Control environment.

Answer: A

While auditors assess control risk as a part of their consideration of internal control, it is not a component
of an entitys internal control.

6. To obtain audit evidence about control risk, an auditor selects tests from a variety of techniques
including

a. Inquiry.
b. Analytical procedures.
c. Calculation.
d. Confirmation.

Answer: A

Auditors test controls to provide evidence for their assessment of control risk through inquiries of
appropriate personnel, inspection of documents and records, observation of the application of controls,
and reperformance of the application of the policy or procedure.

7. Which of the following is not an assertion relating to classes of transactions?

a. Accuracy.
b. Consistency.
c. Cutoff.
d. Occurrence.

Answer: B

The assertions for classes of transactions are occurrence, completeness, accuracy, cutoff and
classification.

8. Operational auditing is primarily oriented toward

a. Future improvements to accomplish the goals of management.

b. The accuracy of data reflected in managements financial
records.
c. The verification that a companys financial statements
are fairly presented.
d. Past protection provided by existing internal control.

Answer: A

Operational audits deal primarily with evaluating the efficiency and effectiveness with which operations
function, often with the intention of making improvements to accomplish the goals of management.
 9. Which of the following types of evidence would an auditor most likely examine to determine
whether controls are operating as designed?

a. Confirmations of receivables verifying account balances.

b. Letters of representations corroborating inventory
pricing.
c. Attorneys responses to the auditors inquiries.
d. Client records documenting the use of computer programs.

Answer: D

Inspection of client records documenting the use of computer programs will provide evidence to help the
auditor evaluate the effectiveness of the design and operation of internal control; the clients control over
use of its computer programs in this case is documentation of the use of the programs. In order to test
this control, the auditor will inspect the documentation records.

10. A procedure that involves tracing a transaction from its origination through the companys
information systems until it is reflected in the companys financial report is referred to as a(n)

a. Analytical analysis.
b. Substantive procedure.
c. Test of a control.
d. Walk-through.

Answer: D

Walk-through is a procedure that involves tracing a transaction from origination through the companys
information systems until it is reflected in the companys financial report.

11. Which of the following is an accurate statement about internal control weaknesses?

a. Material weaknesses are also control deficiencies.

b. Significant deficiencies are also material weaknesses.
c. Control deficiencies are also material weaknesses.
d. All control deficiencies must be communicated to the audit committee.

Answer: A

All material weaknesses are control deficiencies.

12. In an integrated audit, which of the following is defined as a weakness in internal control that is
less severe than a material weakness but important enough to warrant attention by those
responsible for oversight of the financial reporting function?

a. Control deficiency.
b. Unusual weakness.
c. Unusual deficiency.
d. Significant deficiency.

Answer: D

Significant deficiency is defined as a weakness in internal control that is less severe than a material
weakness but important enough to warrant attention by those responsible for oversight of the financial
reporting function.
 13. Proper authorization of write-offs of uncollectible accounts should be approved in which of the
following departments?

a. Accounts receivable.
b. Credit.
c. Accounts payable.
d. Treasurer.

Answer: D

The treasurers department is the department responsible for bad debt write-offs. It should be
independent of the sales, credit, and the recordkeeping for that function, and should have knowledge to
help make proper decisions of this nature.

14. Proper segregation of functional responsibilities calls for separation of the functions of

a. Authorization, execution, and payment.

b. Authorization, recording, and custody.
c. Custody, execution, and reporting.
d. Authorization, payment, and recording.

Answer: B

Authorizing transactions, recording transactions, and maintaining custody of assets should be

segregated.

15. Relationship between control risk and detection risk is ordinarily

a. Parallel.
b. Inverse.
c. Direct.
d. Equal.

Answer: B

Control risk and detection risk has an inverse relationship with each other. As control risk increases
(decreases) detection risk must decrease (increase).

16. An auditor suspects that certain client employees are ordering merchandise for themselves over
the Internet without recording the purchase or receipt of the merchandise. When vendors
invoices arrive, one of the employees approves the invoices for payment. After the invoices are
paid, the employee destroys the invoices and the related vouchers. In gathering evidence
regarding the fraud, the auditor most likely would select items for testing from the file of all

a. Cash disbursements.
b. Approved vouchers.
c. Receiving reports.
d. Vendors invoices.

Answer: A
The requirement is to determine the most likely population from which an auditor would
sample when vendors invoices and related vouchers relating to purchases made by
employees have been destroyed. Answer (a) is correct because the disbursement will be
recorded and the auditor may thus sample from that population. Answers (b) and (d) are
 incorrect because the related vouchers and vendors invoices are destroyed. Answer (c) is
incorrect because there is no recording of the receipt of the merchandise.

17. Which of the following statements is correct concerning an auditors assessment of control risk?

a. Assessing control risk may be performed concurrently during an audit with obtaining an
understanding of the entitys internal control.
b. Evidence about the operation of internal control in prior audits may not be considered
during the current years assessment of control risk.
c. The basis for an auditors conclusions about the assessed level of control risk need not
be documented unless control risk is assessed at the maximum level.
d. The lower the assessed level of control risk, the less assurance the evidence must
provide that the control procedures are operating effectively.

Answer: A
The requirement is to identify the correct statement concerning an auditors assessment
of control risk. Answer (a) is correct because AU-C 315 indicates that assessing control
risk may be performed concurrently during an audit with obtaining an understanding of
internal control. Answer (b) is incorrect because evidence about the operation of internal
control obtained in prior audits may be considered during the current years assessment
of control risk. Answer (c) is incorrect because the basis for an auditors conclusions
about the assessed level of control risk needs to be documented when control risk is
assessed at levels other than the maximum level. Answer (d) is incorrect because a lower
level of control risk requires more assurance that the control procedures are operating
effectively.

18. Which of the following is correct concerning the level of assistance auditors may provide in
assisting management with its assessment of internal control?

a. No assistance of any type may be provided.

b. No limitations on assistance exist.
c. Only very limited assistance may be provided.
d. As less risk is assumed by the auditors, a higher level of assistance is appropriate.

Answer: C
The requirement is to identify the correct statement concerning the level of assistance that
auditors may provide in assisting management with its assessment of internal control.
Answer (c) is correct since only limited assistance may be provided so as not to create a
situation in which the auditors are auditing their own work. Answer (a) is incorrect since
some assistance may be provided. Answer (b) is incorrect because there are limitations on
the level of assistance. Answer (d) is incorrect because the tie between risk and
assistance seems inappropriate and in the wrong direction; also, this type of tradeoff
between risk and assistance is not included in PCAOB Standard 5.

19. Criteria that are embodied in laws or regulations, or issued by authorized or recognized bodies of
experts that follow a transparent due process are called

a. Suitable criteria
b. Established criteria
c. Specifically developed criteria
d. General criteria

Answer: B
 Established criteria are those that are embodied in laws or regulations, or issued by authorized or
recognized bodies.

20. What assurance is provided by the auditor in an agreed-upon procedures engagement?

a. Reasonable
b. Absolute
c. Moderate
d. No assurance

Answer: D
In an agreed-upon procedures engagement, the auditor simply provides a report of the factual
findings and expresses no assurance in his/her report.

Average

1. As the acceptable level of detection risk decreases, the assurance directly provided from

a. Substantive tests should increase.

b. Substantive tests should decrease.
c. Tests of controls should increase.
d. Tests of controls should decrease.

Answer A

The requirement is to identify an effect of a decrease in the acceptable level of detection risk. Answer (a)
is correct because as the acceptable level of detection risk decreases, the assurance provided from
substantive tests should increase. To gain this increased assurance the auditors may (1) change the nature
of substantive tests to more effective procedures (e.g., use independent parties outside the entity rather
than those within the entity), (2) change the timing of substantive tests (e.g., per form them at year-end
rather than at an interim date), and (3) change the extent of substantive tests (e.g., take a larger sample).
Answer (b) is incorrect because the assurance provided from substantive tests increases, it does not
decrease. Answers (c) and (d) are incorrect because the acceptable level of detection risk is based largely
on the assessed levels of control risk and inherent risk. Accordingly, any tests of controls will already have
been performed.

2. According to the standards of the profession, which of the following activities would most likely not
impair a CPAs independence?

A. Providing advisory services for a client.

B. Contracting with a client to supervise the clients office personnel
C. Signing a clients checks in emergency situations.
D. Accepting a luxurious gift from a client.

Answer A
The requirement is to determine the activity that would most likely not impair a CPAs independence.
Accounting and consulting services do not normally impair independence because the members role is
advisory in nature. Answers (b) and (c) are incorrect because management functions are being performed.
Answer (d) is incorrect because accepting a luxurious gift impairs a CPAs independence.

3. The bank statement for December 2017 contains the following data:

Total deposits P110,000

Total charges. including an NSF check of P8,000 and a

service charge of P400 96,000

All outstanding checks on November 30, 2017, including the bank credit, were cleared in the bank
in December 2017.
There were outstanding checks of P30,000 and deposits in transit of P38,000 on December 31, 2017.

How much is the cash balance per bank on December 31, 2017?

a. P154,000 c. P164,000

b. P150.000 d. P172,400

Answer: C

Balance per bank, Nov. 30, 2006 P 150,000

Add: Total deposits per bank statement 110,000
Total 260,000
Less: Total charges per bank statement 96,000
Balance per bank, Dec. 31, 2006 P164,000

4. The management of a client company believes that the statement of cash flow is not a useful document
and refuses to include one in the annual report to stockholders. As a result, the auditor's opinion should
be

a. Qualified due to inadequate disclosure.

b. Qualified due to a scope limitation.
c. Adverse.
d. Unqualified.

Answer A

A management that refuses to include one in the annual report to stockholders would result to a qualified
opinion due to inadequate disclosure

5. An auditor would issue an adverse opinion if

a. The audit was begun by other independent auditors who withdrew from the engagement.
b. A qualified opinion cannot be given because the auditor lacks independence.
c. The restriction on the scope of the audit was significant.
d. The statements taken as a whole do not fairly present the financial position, results of operations,
and cash flows of the company.
e.
Answer D.
An auditor would issue an adverse opinion if the statements taken as a whole do not fairly present the
financial position, results of operations, and cash flows of the company.

6. The fourth reporting standard requires that the auditor's report contain either an expression of opinion
regarding the financial statements taken as a whole or an assertion that an opinion cannot be
expressed. The objective of the fourth standard is to prevent

a. An auditor from reporting on one basic financial statement and not the others.
b. An auditor from expressing different opinions on each of the basic financial statements.
c. Management from reducing its responsibility for the basic financial statements.
d. Misinterpretations about the degree of responsibility the auditor assumes.

Answer: D

The objective of the fourth standard is to prevent misinterpretations about the degree of responsibility the
auditor assumes.

7. An auditor's opinion reads as follows: "In our opinion, except for the above-mentioned limitation on
the scope of our audit... This is an example of a

a. Review opinion.
b. Emphasis on a matter.
c. Qualified opinion.
d. Unacceptable reporting practice.

Answer: D
Except for the above-mentioned limitation on the scope of our audit is unacceptable phrase in reporting
practice

8. An auditor's report includes a statement that "the financial statements do not present fairly the financial
position in conformity with generally accepted accounting principles." This auditor's report was
probably issued in connection with financial statements that were

a. Prepared on a comprehensive basis for accounting other than GAAP.

b. Restricted for use by management.
c. Misleading.
d. Condensed.
Answer: C
An auditor's report that says "the financial statements do not present fairly the financial position in
conformity with generally accepted accounting principles." was issued in connection with financial
statements that were misleading.

9. If the auditor believes there is minimal likelihood that resolution of an uncertainty will have a material
effect on the financial statements, the auditor would issue a(n)

a. Qualified opinion.
b. Adverse opinion.
c. Unqualified opinion.
 d. Disclaimer of opinion.
Answer: C
The auditor would issue an unqualified opinion if a minimal likelihood that resolution of an uncertainty will
have a material effect on the financial statements

10. If an accounting change has no material effect on the financial statements in the current year but the
change is reasonably certain to have a material effect in later years, the change should be

a. Treated as a consistency modification in the auditor's report for the current year.
b. Disclosed in the notes to the financial statements of the current year.
c. Disclosed in the notes to the financial statements and referred to in the auditor's report for the
current year.
d. Treated as a subsequent event.

Answer B
If the change is reasonably certain to have a material effect in later years, the change should be disclosed
in the notes to the financial statements of the current year.

11. In which of the following situations would the auditor appropriately issue a standard unqualified report
with no explanatory paragraph concerning consistency?

a. A change in the method of accounting for specific subsidiaries that comprise the group of
companies for which consolidated statements are presented.
b. A change from an accounting principle that is not generally accepted to one that is generally
accepted.
c. A change in the percentage used to calculate the provision for warranty expense.
d. Correction of a mistake in the application of a generally accepted accounting principle.

Answer: C

A change in the percentage used to calculate the provision for warranty expense would result to a
standard unqualified report with no explanatory paragraph concerning consistency.

12. When financial statements are presented that are not in conformity with generally accepted
accounting principles, an auditor may issue a(n)

Qualified Adverse
opinion opinion

a. Yes No
b. Yes Yes
c. No Yes
d. No No

Answer B

A qualified or an adverse opinion is issued when the financial statements are not presented in conformity
with generally accounting principles.

13. The tolerable rate of deviation for tests of controls necessary to justify a control risk assessment
depends primarily on which of the following?

a. The cause of errors.

 b. The extent of reliance to be placed on the procedures.
c. The amount of any substantive errors.
d. The limit used in audits of similar clients.

Answer B

The tolerable rate of deviation for tests of controls necessary to justify a control risk assessment depends
primarily on the extent of reliance to be placed on the procedures.

14. Which of the following is an element of sampling risk?

a. Choosing an audit procedure that is inconsistent with the audit objective.

b. Choosing a sample size that is too small to achieve the sampling objective.
c. Failing to detect an error on a document that has been inspected by the auditor.
d. Failing to perform audit procedures that are required by the sampling plan.

Answer B

Choosing a sample size that is too small to achieve the sampling objective is an element of sampling risk

15. At times, a sample may indicate that the auditor's assessed level of control risk for a given control is
reasonable when, in fact, the true compliance rate does not justify the assessed level. This situation
illustrates the risk of

a. Assessing control risk too low.

b. Assessing control risk too high.
c. Incorrect precision.
d. Incorrect rejection.

Answer A

Assessing control risk too low indicates that the auditor's assessed level of control risk reasonable when
in fact not.

16. Which of the following is not an attestation standard?

a. Sufficient evidence shall be obtained to provide a reasonable basis for the conclusion that is
expressed in the report.
b. The report shall identify the subject matter on the assertion being reported on and state the
character of the engagement.
c. The work shall be adequately planned and assistants, if any, shall be properly supervised.
d. A sufficient understanding of internal control shall be obtained to plan the engagement.

Answer: D

There is no internal control standard because the concept of internal control may not be relevant to
certain assertions on which a CPA may be engaged to report (e.g., aspects of information about
computer software). Answers a, b, and c are all incorrect because standards exist for evidence, reporting
on the assertion or subject matter, and proper planning.

17. Analytical procedures used during risk assessment in an audit should focus on
 a. Reducing the scope of tests of controls and substantive tests.
b. Providing assurance that potential material misstatements will be identified.
c. Enhancing the auditors understanding of the clients business.
d. Assessing the adequacy of the available evidence.

Answer: C

Analytical procedures used during risk assessment may enhance the auditors understanding of the
clients business and significant transactions and events that have occurred since the prior audit and also
may help to identify the existence of unusual transactions or events and amounts, ratios, and trends that
might indicate matters that have audit implications.

18. Which of the following combinations results in a decrease in sample size in a sample for attributes?

Expected
Risk of assessing
Tolerable Rate Population
control risk too low
Deviation Rate

a. Increase Decrease Increase

b. Decrease Increase Decrease
c Increase Increase Decrease
d. Increase Increase Increase

Answer: C

The sample size will decrease when the risk of assessing control risk too low is increased, the tolerable
rate is increased, and the expected population deviation rate is decreased.

19. On January 17, 2018, an explosion occurred at a Sims Co. plant causing extensive property damage
to area buildings. Although no claims had yet been asserted against Sims by March 10, 2018, Sims
management and counsel concluded that it is likely that claims will be asserted and that it is
reasonably possible Sims will be responsible for damages. Sims management believed that
P1,250,000 would be a reasonable estimate of its liability. Sims P5,000,000 comprehensive public
liability policy has a P250,000 deductible clause. In Sims December 31, 2017 financial statements,
which were issued on March 25, 2018, how should this item be reported?

a. As an accrued liability of P250,000.

b. As a footnote disclosure indicating the possible loss of P250,000.
c. As a footnote disclosure indicating the possible loss of P1,250,000.
d. No footnote disclosure or accrual is necessary.

Answer: B

A loss contingency should be accrued if it is probable that a liability has been incurred at the balance
sheet date and the amount of the loss is reasonably estimable. With respect to unfiled claims, the
enterprise must consider both the probability that a claim will be filed and the probability of an unfavorable
outcome. Although it is probable that claims will be asserted against Sims, it is only reasonably possible
that the claims will be successful. Therefore, this contingent liability should not be accrued, but should be
disclosed. The potential loss to be disclosed is P250,000, since the additional amount above the
deductible would be covered by the insurance.

20. Each page of the financial information compiled by the accountant should include the following
reference, except

a. Unaudited
b. Compiled without Audit or Review
c. Refer to Compilation Report
d. Compiled, Negative Assurance Expressed

Answer: D
According to PSRS 4410 (Engagement to Compile Financial Information), the financial information
compiled by the accountant should contain a reference such as:
Unaudited;
Compiled without Audit or Review
Refer to Compilation Report
on each page of the financial information or on the front of the complete set of financial statement.

Difficult

1. According to the ethical standards of the profession, which of the following acts is generally
prohibited?

a. Purchasing a product from a third party and reselling it to a client.

b. Writing a financial management newsletter promoted and sold by a publishing company.
c. Accepting a commission for recommending a product to an audit client.
d. Accepting engagements obtained through the efforts of third parties.

Answer: C
The requirement is to determine which act is generally prohibited. Answer (c) is correct because
a member in public practice shall not for a commission recommend or refer to a client any
product or service, or for a commission recommend or refer any product or service to be supplied
by a client, or receive a commission when the member or the members firm perform for that
client: (1) an audit of a financial statement; or (2) a compilation of a financial statement when the
member expects that a third party will use the financial statement and the members

2. On June 1, 20X8, a CPA obtained a $100,000 personal loan from a financial institution client for
whom the CPA provided compilation services. The loan was fully secured and considered
material to the CPAs net worth. The CPA paid the loan in full on December 31, 20X9. On April 3,
20X9, the client asked the CPA to audit the clients financial statements for the year ended
December 31, 20X9. Is the CPA considered independent with respect to the audit of the clients
December 31, 20X9 financial statements?

a. Yes, because the loan was fully secured.

b. Yes, because the CPA was not required to be independent at the time the loan was
granted.
 c. No, because the CPA had a loan with the client during the period of a professional
engagement.
d. No, because the CPA had a loan with the client during the period covered by the financial
statements.

Answer: B
Independence was not required at the time the loan was obtained, and because it is fully secured
it is grandfathered by 101-5. Answer (a) is incorrect because if the CPA is required to be
independent, a mortgage loan would not be permitted even if it was fully secured. Answer (c) is
incorrect because the CPA was not required to be independent of the client. Answer (d) is
incorrect because the CPA was not required to be independent of the client.

3. Which of the following is not true about international auditing standards?

a. International auditing standards do not require an audit of internal control.

b. International auditing standards do not allow reference to division of responsibilities in the
audit report.
c. International auditing standards require obtaining an attorneys letter.
d. International auditing standards are based on a risk assessment approach.

Answer: C
The requirement is to identify the item that is not true about international auditing standards.
Answer (c) is correct because international auditing standards require obtaining an attorneys
letter only if the auditors assess a risk of material misstatement. Answers (a), (b) and (d) are
incorrect because they are all true about international auditing standards.

4. Which of the following is most likely to be a response to the auditors assessment that the risk of
material misstatement due to fraud for the existence of inventory is high?

a. Observe test counts of inventory at certain locations on an unannounced basis.

b. Perform analytical procedures rather than taking test counts.
c. Request that inventories be counted prior to year-end.
d. Request that inventory counts at the various locations be counted on different dates so
as to allow the same auditor to be present at every count.

Answer: A
The requirement is to identify the most likely response to the auditors assessment that the risk of
material misstatement due to fraud for the existence of inventory is high. Answer (a) is correct
because observing test counts of inventory on an unannounced basis will provide evidence as to
whether record inventory exists. Answer (b) is incorrect because replacing test counts with
analytical procedures is not likely to be particularly effective. Answers (c) and (d) are incorrect
because the inventories might well be counted at year-end, all on the same date, rather than prior
to year-end and at differing dates.

5. Which of the following statements best describes the auditors responsibility to detect conditions
relating to financial stress of employees or adverse relationships between a company and its
employees?

a. The auditor is required to plan the audit to detect these conditions on all audits.
b. These conditions relate to fraudulent financial reporting, and an auditor is required to plan
the audit to detect these conditions when the client is exposed to a risk of
misappropriation of assets.
 c. The auditor is required to plan the audit to detect these conditions whenever they may
result in misstatements.
d. The auditor is not required to plan the audit to discover these conditions, but should
consider them if he or she becomes aware of them during the audit.

Answer: D
The requirement is to identify an auditors responsibility for detecting financial stress of
employees or adverse relationships between a company and its employees. Answer (d) is correct
because AU-C 240 states that, while the auditor is not required to plan the audit to discover
information that is indicative of financial stress of employees or adverse relationships between the
company and its employees, such conditions must be considered when an auditor becomes
aware of them. Answers (a), (b), and (c) are all incorrect because the auditor does not plan the
audit to detect these conditions.

6. Chapel Company provided the following information in relation to the audit of its financial
statements:

2017 2016
Cash and cash equivalents 5,300,000 1,200,000
Accounts receivable 5,000,000 2,500,000
Inventory 2,000,000 1,500,000
Prepaid expenses 1,100,000 1,600,000
Investment in associate 40% 22,000,000 19,000,000
Property, plant and equipment 17,000,000 22,500,000
Accumulated depreciation 5,000,000 6,000,000
Accounts payable 5,000,000 12,500,000
Income tax payable 2,000,000 1,000,000
Deferred tax liability 3,000,000 2,000,000
Share capital 13,000.000 6,500,000
Retained earnings 24,500,000 20,000,000
The net income for 2017 was P16,500,000.
Equipment with carrying amount of P7,500,000 and original cost of 10,500,000 was sold for
P7,000,000 during 2017. New equipment was purchased for cash in 2017.
The entity issued share capital and declared and paid cash dividends of P12,000,000 to
shareholders on December 31, 2017.
The sales amounted to P30,000,000 and the cost of goods sold was P10,000,000 for the current
year.
The associate reported net income of P10,000,000 and paid cash dividend of P2,500,000 during
2017.
What is the net cash provided by operating activities?

a. 11,000,000
b. 12,000,000
c. 9,000,000
d. 8,000,000

Answer: D

Net income 16,500,000

Loss on disposal 500,000
Share in net income (4,000,000)
Dividend received 1,000,000
Accounts receivable (2,500,000)
 Inventory (500,000)
Prepaid expenses 500,000
Depreciation 2,000,000
Accounts payable (7,500,000)
Income tax payable 1,000,000
Deferred tax liability 1,000,000
Net cash provided by operating activities 8,000,000

7. Red Company reported net income of P7,410,000 for the current year. The auditor raised
questions about the following amounts that had been included in the net income:

Equity in earnings of Chester Company 40% interest P1,700,000

Dividend received from Chester Company 300,000
Unrealized loss on available for sale investments (540,000)
Gain on early retirement of bonds payable 2,100,000
Adjustment of profit of prior year for error in depreciation, net of tax effect (750,000)
Loss from fire (1,500,000)
Gain from change in fair value attributable to credit risk of financial liability 500,000
at FVPL
What should be reported as adjusted net income?

a. 8,200,000
b. 9,500,000
c. 7,900,000
d. 8,400,000

Answer: C

Unadjusted net income 7,410,000

Dividend received from Chester Company (300,000)
Unrealized loss on available for sale investments 540,000
Adjustment of profit of prior year for error in depreciation, net of tax effect 750,000
Gain from change in fair value attributable to credit risk of financial liability 500,000
at FVPL
Adjusted net income 7900,000

8. Blue, Inc. was organized on January 1, 2017. On December 31, 2018, the company lost most of
its inventory in a warehouse fire just before the yearend count of inventory was to take place. The
companys records disclosed the following data:

2017 2018
Inventory, January 1 P 0 P204,000
Purchases 860,000 692,000
Purchase returns and allowances 46,120 64,600
Sales 788,000 836,000
Sales returns and allowances 16,000 20,000
On January 1, 2018, Blues pricing policy was changed so that the gross profit rate would be
three percentage points higher than the one earned in 2017. Salvaged undamaged merchandise
was marked to sell at P24,000 while damaged merchandise marked to sell at P16,000 had an
estimated realizable value of P3,600. How much is the inventory fire loss?

a. P189,000
b. P183,640
 c. P164,920
d. P254,000

Answer: A

Inventory, January 1. 2018 P204,000

Add: Net Purchases (P692,000-64,600) 627,400
Goods available for sale 831,400
Less: Cost of goods sold:
Net Sales (836,000-20,000) P816,000
Cost ratio (100%-24%*) X76% 620,160
Estimated ending inventory 211,240
Less: Salvaged undamaged merchandise (P24,000x76%) P18,240
Net realizable value of damaged merchandise 3,600 21,840
Inventory fire loss P189,400
*The gross profit rate used for 2018 is computed by adding 3% to 21% gross profit rate for 2017
which is computed as follows:

Net Sales (P788,000-16,000) P772,000

Cost of goods sold:
Net purchases (P860,000-46,120) P813,880
Less: Inventory, December 31, 2017 204,000 609,880
Gross Profit, 2017 P162,120
Gross Profit rate, 2017 (P162,120/772,000) 21%

9. Ashley, Co. is authorized to issue 300,000 of P2 par value ordinary shares. The company has the
following transactions:

Issued 60,000 shares at P30 per share; received cash.

Issued 750 shares; selling at P35 per share, to lawyers for services in connection
with the organization of the corporation. The value of legal services was P27,000.
Issued 900 shares, valued objectively at P30,000, to the employees instead of paying
them cash wages.
Issued 37,500 shares in exchange for a building valued at P885,000 and land valued
at P240,000. (The building was originally acquired by the investor for P750,000 and
has P300,000 of accumulated depreciation; the land was originally acquired for
P90,000)
Received cash for 19,500 shares issued at P38 per share.
Issued 12,000 shares at P45 per share; received cash.
The statement of financial position will report share premium of:

a. P4,000,950
b. P3,973,500
c. P4,001,700
d. P3,326,700

Answer: C

P28 x 60,000 P1,680,000

P27 (2 x 750) 25,500
P30,000 (P2 x 900) 28200
P885,000 + P240,000 = P1,125,000 (P2 x 37,500) 1,050,000
P36 x 19,500 702,000
 P43 x 12,000 516,000
Total share premium P4,001,700

10. Kim Company and its subsidiaries provided the following properties owned by the group.

Land held for undetermined future use P2,000,000

Vacant building to be leased out under an 3,000,000
operating lease
Property held for use in production 5,000,000
Property held by a subsidiary, a real estate firm, 4,000,000
in the ordinary course of business
Building owned by subsidiary and for which the 3,500,000
subsidiary provides security and maintenance
services to the lessees
Land leased to a subsidiary under an operating 2,500,000
lease
Equipment leased to an unrelated party under 1,000,000
an operating lease
Building under construction for use as 3,500,000
investment property

In the consolidated statement of financial position of the parent and its subsidiaries, what total
amount should be reported as investment property?
a. 12,000,000
b. 10,000,000
c. 8,500,000
d. 6,500,000

Answer: A

Land held for undetermined future use P2,000,000

Vacant building to be leased out under an operating lease 3,000,000
Building owned by subsidiary and for which the subsidiary provides
security and maintenance services to the lessees 3,500,000
Building under construction for use as investment property 3,500,000
TOTAL P12,000,000