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

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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

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

and Sept. 30 stock, to stockholders of record on March 15 and
September 15, respectively. France did not pay
dividends on its common stock during 2006.

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 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

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Question No. 2
Sales proceeds (2,500 shares x P45) P112,500
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:

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Particulars Date Ref. DR CR
Purchase of GOOD Co. – 1-14 CV P 960,000
4,000 shares
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 01-02 01-15 01-31 P20/share
Stock 05-02 05-15 05-31 10%
Cash 08-01 08-30 09-15 P30/share

At December 31, 2006, GOOD and LUCK shares were selling at P210 and
P240 per share, respectively.

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

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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
Sales proceeds P184,000
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

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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 Purchased 20,000 shares
common, par value P50,
BUSTOS Co. VR-69 780,000
03/30 10,000 shares BUSTOS Co.
received as stock dividend CJ-30 500,000
04/03 Sold 10,000 shares @ P25 CR-44 250,000
12/02 Sold 4,000 shares @ P60 CR-65 240,000

Dividend Income
Date Description Ref. Debit Credit
03/30 Stock dividend SJ-8 500,000
08/30 BUSTOS Company common CR-52 100,000

The following information was obtained during your examination:

1. From independent sources, you determine the following dividend
information:
Type of Date Date of Date of
Dividend Declared Record Payment Rate
Stock 02/14/2006 02/28/2006 03/30/2006 50%
Cash 08/01/2006 08/15/2006 08/30/2006 P5/share
Cash 12/01/2006 12/15/2006 01/02/2007 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

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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
Sales proceeds (10,000 shares x P25) P250,000
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 P100,000
(20,000 shares x P5)
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

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 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

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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:
Based on the above and the result of your audit, determine the following:
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
a. P4,800 loss c. P1,600 loss
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

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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
Sales proceeds P76,000
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
Sales proceeds (1,600 shares x P15) P24,000
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:
Sales proceeds (1,600 shares x P15) P24,000
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%

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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

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

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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

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 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.

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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*

119
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
Cost/
Shares 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
Sales proceeds (2,500 shares x P150) P375,000
Less cost of investment sold (see no. 3) 180,000
Gain on sale of stock dividend received P195,000

Question No. 5
Sales proceeds (5,000 shares x P120) P600,000
Less cost of investment sold (see no. 3) 180,000
Gain on sale of investment in 8/2006 P420,000

120
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:
Based on the above and the result of your audit, answer the following:
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

121
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

122
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:
Based on the above and the result of your audit, determine the following:
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

123
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
Carrying value, 12/31/04 P2,420,000

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
Carrying value, 12/31/05 P2,442,400

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
Carrying value, 12/31/05 P2,442,400
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:

124
 Unrealized
Cost Market 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

125
 FVR reported net income and paid dividends of:
Dividend
Net income 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:
Based on the above and the result of your audit, determine the following:
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

126
 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.

127
Question No. 5
Sales proceeds P37,600
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:
Based on the above and the result of your audit, determine the following:
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
a. P6,861 loss c. P4,849 loss
b. P4,714 loss d. P9,416 gain

128
Suggested Solution:

Question No. 1
The following amortization schedule will be useful in computing for the
requirements:
Effective Nominal Discount Carrying
Date interest interest amortization 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
Total interest income for 2004 P18,517

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
Total interest income for 2005 P18,775

129
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
Unrealized loss on AFS 3,486
Available for sale securities P6,861

Question No. 5
Sales proceeds P185,000
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
Unrealized loss on AFS 3,486

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.

130
QUESTIONS:
Based on the above and the result of your audit, determine the following:
(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
Total interest income for 2005 P212,829
a
Computation of carrying value,12/1/05:
Carrying value, 6/1/05 P3,645,328
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
Carrying value, 12/1/05 P3,667,594

131
Question No. 3
Carrying value, 12/1/05 (see no. 2) P3,667,594
Add discount amortization,
12/1/05 to 12/31/05:
Effective interest (P3,667,594 x 10% x 1/12) P30,563
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
Total interest income for 2006 P306,620
b
Computation of carrying value,6/1/06:
Carrying value, 12/1/05 P3,667,594
Add discount amortization,
12/1/05 to 5/31/06
Effective interest (P3,667,594 x 10% x 6/12) P183,380
Nominal interest (P4,000,000 x 8% x 6/12) 160,000 23,380
Carrying value, 6/1/06 P3,690,974

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:

Carrying value, 6/1/06 (see no. 4) P3,690,974
Add discount amortization,
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
Carrying value, 11/1/06 P3,711,432

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

132
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:
Based on the above and the result of your audit, determine the following:
(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

133
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
Total interest income for 2003 P105,600

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
Carrying value, 12/31/03 P1,561,600

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

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

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

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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.

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 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:

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 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.

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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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