Chapter 1 BASIC CONCEPTS OF FINANCIAL STATEMENT AUDIT SEES ISSO ISO OO IOC TOI IDOI ATID I TOD IIIA A AIT EXPECTED LEARNING OUTCOMES After reading this chapter, you should be able to (a) recall the nature of a financial statement audit by stating its purpose; (>) identify the management's assertions when presenting the financial statements; (©) describe each major phase in financial statement audit; (@) . identify and discuss the most common procedures applied in financial statement audit; (e) explain the purpose of audit documentation; (f) state the type appropriate type of audit report for each conclusion drawn based on assessment of audit documentation; (g) __ formulate appropriate audit adjusting entries; and (h) complete a working trial balance. THE PURPOSE OF FINANCIAL STATEMENT AUDIT AND MANAGEMENT'S ASSERTIONS Financial statements are primarily the responsibility of the entity’s management who makes the following assertions: + existence or occurrence of transactions that result to reported assets, liabilities and equity at the reporting date and income and expenses for the reporting period, + completeness of information presented in the financial statements that are the results of the transactions and other events that actually occurred during the reporting period. t or controf over all reported assets, and obligations for reported ies at the reporting date, appropriate use of measurement bases for assets, liabilities and equity and recognition of income and expenses in accordance with the revenue and expense recognition principles applicable; andChapter 1 ~ Basie Concepts of Financial Statement Audit sapter dt ~ . jate presentation and disclosure of all_ financial ipenens me accompanying notes to the financial state effect that the substance and not merely the legal form of transactions is communicated to the users. ments Te the "ecordeg External users, mainly investors and other stakeholders, use ty information contained in the financial statements in making judgments abo. enterprise to formulate decisions, There may be instances, however, that a specif: concern.of the entty’s management may be in confct with the information next of the users. Thus, an external audit is necessary to determine whether e financial statements issued by the management are free of biases and are prepa: in accordance with the appropriate financial reporting framework. This reporting framework aims to present information that is relevant and reliable for the decsigy needs of the external users. The external auditor conducts an independent examination of the financial statements to address each of the foregoing assertions of the management, THE AUDIT PROCESS The audit process starts when a reporting entity engages the services of an Independent auditor for an independent examination of its financial statements anid concludes when an auditor issues an audit opinion based on the assessment of the evidence gathered in the course of the conduct of audit procedures and assessment of evidence gathered therefrom. The following are the major phases in a financial statement audit: (2) _ pre-engagement activities; (b) audit planning and evaluation of internal control; (©) evidence gathering; and (@) reporting, (a) _Pre-Engagement Activities cams’ at 2 new engagement or retain an existing client. In making an the client’s busi eporting practi i jit id resourecs Whether he or she seu te tng Practices. Likewise, the aualtor shoul ctivities are designed to Manage conflicts and Pre-engagement activities are Procedures conducted to determine whether Should corsage a etether to accept of reject @ prospective client, the auditor “eraser and the client’: mass, Putation, the changes in client’s ownership ether Cr her audit team possess the necessary ski, plete the audit within the period specified by the ~The sessment As or aru not accept an engagement, when based Pendence would be compromised. Jn ‘hapte repeat determi accepte (b) extent require down t (©) objecti suffici audit Docun refers relevar of bo corrabi writter data. examir transac were ¢ merely objecti assessChapter 1 - Basic Concepts of Financial Statement Audit repeat engagements, subsequent relationships established shall be assessed to determine whether independence has not been compromised. If the engagement is accepted or retained, the terms shall be documented in an engagement letter. (b) Audit Planning Audit planning involves evaluation of internal control to determine the extent of audit procedures necessary to be performed. The audit planning phase requires active involvement of the whole audit team, from the partner in charge down to the audit staff. It includes the following tasks: (1) obtaining an understanding of the client, its business, industry and accounting policies; (2) obtaining an understanding of the client's internal control system; (3) assessing materiality and audit risk; (4) identifying audit objectives; (5) determining whether reliance can be placed on certain controls in the system; (6) determining the nature, extent and timing of substantive tests to be performed; and (7). designing and finalizing the audit program. (©) Evidence-Gathering or Audit Documentation ‘The evidence-gathering (audit documentation) phase must accomplish the objective of documenting the fact that the audit was adequately planned and sufficient, competent evidential matter is obtained that serves as the basis for the audit opinion reached (International Standards on Auditing 230 Auait Documentation par. 5). The evidence gathered must both be sufficient and competent. Sufficiency refers to the quantity of evidence an auditor acquires and competence refers to the relevance, validity and reliability of the evidence acquired, Audit evidence consists ‘of both accounting data (business documents, journals and ledgers) and corroborating information (cancelled checks, invoices, contracts, promissory notes, written representations from customers and vendors, etc.) that supports accounting data, Because of the time element involved in completing the audit, the examination of evidence is made on a test basis. The auditors test samples of transactions and generalize the results to the population from which the samples were drawn. This requires that the evidence gathered be persuasive rather than merely convincing. _ The audit procedures applied by the auditor are selected based on the audit objectives, the quantity and types of evidence available, materiality and the assessed level of audit risk. An audit evidence acquired may address one or moreinstances, a series of audit procedures ma Y be audit objectives, and in some i ‘objective. The following are the jt 19 Most com; necessary to address one audit audit procedures applied by the al + Confirmation - o! + Physical count and observ Inquiry — obtaining writ employees and others; example: etc:); + — Recalculation: * Mechanical tests of data data (tracings, footings an The foregoing and other au Tests of controls are of controls and substantive tests. ability of the company’s misstatements. Substantive tests, to detect material mis analytical procedures ‘performed balance, transaction class or fini Substantive tests may be classifie Tests of details are intended to to test aggregated data. non-financial data. Anal to reach a conclusion. Audit evidence must both be sufficier document, th shall contain the source of the performed, and the conclusions re evidence gathered. The extent of tt experienced auditor with no previous connection wil understand the nature, timing, ex evidence obtained, and conclusions Documentation must be made immediately after completing procedure, Documentation ~ obtaining internal eviden contracts, minutes. of meetings, Comparisons — establishing trends and val 15 — establishing correctness of account balances; detect material misstat ‘Analytical procedures Formation made by a study of plausible relations jytical procedures allow the at juditor: taining written statements from a third party; ation; ten and oral information from managemen, ce and external evidence (for vouchers, bank statements lid relationships of information; and — verifying mathematical accuracy of accounting id cross-footings). dit procedures are carried out to perform tests conducted to assess the internal controls to prevé are tests of details and ‘on the other hand, statements in account ancial_ statement presentation and disclosure. details or analytical procedures. tement and allow an auditor 5 are evaluations of financial hips among both financial and uditor to test aggregated date d into tests of nt and competent. The documentation e clear purpose of the audit procedure ached based on the procedure performed and he documentations should be sufficient for a" ith the engagement t rocedures performesy tent and results of PI reached. an audit Typical examples of audit documents are entity @ (@) Eeermeton hat enables the auditor to accept or reject an ® elent (hi formation relating to the prospective client’s indust'Y s of the Board of Directors, products manufactured, ett:)i 4 —=—=— |Chapter 1 - Basic Concepts of Finan 1 Statement Audit (b) information that enables the auditor to determine the audit approach (information relating to the effectiveness of internal control procedures and whether or not such procedures are being complied with); (©)_ information as to whether a particular financial statement account balance is complete, valid and accurate and (d) information relating to the completeness, validity and accuracy of the financial statements taken as a whole including information relating to the consistency of the financial statements with the auditor's knowledge of the business The form, content and extent of audit documentation depend on factors, such as (ISA 230 A2) + the size and complexity of the entity; + the nature of the audit procedures to be performed; + the identified risks of material misstatements; + the significance of the audit evidence obtained; + the nature and extent of exceptions identified; + the need to document a conclusion or the basis for a conclusion not readily determinable from the documentation of the work performed or evidence obtained; + the audit methodology and tools used. Specifically, the audit file documentation serves to: (2) organize and coordinate all phases of the audit engagement; (b) provide evidence to demonstrate that the planned audit procedures were in fact performed (6) aid partners in reviewing the work performed by audit staff members; (d) provide evidence that the auditors complied with the auditing standards; (e) document the judgments involved in forming the audit opinion; (A) aid in planning and conducting future audits of the client; and (g) provide information in rendering additional services to the audit client (say, in preparing income tax returns and in making recommendations for improvement of the client’s internal control procedures.) In the risk response phase, typical audit document ir phase, tation normally includes the following items: an audit plan that addresses all material financial ‘UneEXPECTED LEARNING OUTCOMES After reading this chapter, you should be able to () apply’ the new IFRS 9 for classification, initial recognition, or feuvement and presentation of financial assets in the statement Of financial position: (b) identify internal control procedures relating to investment securities; (©) state the auditor's principal objectives in auditing investments and related revenues; (@) apply audit procedures investments and related revenue balances; (4) prepare working papers to establish correct balances of investments and related revenues (9 “formulate audit adjustments to bring investments and related revenues to correct balances; and evaluate the appropriateness of the presentation of investments and related revenues in the financial statements, to establish management's assertions on (9) INVESTMENT CLASSIFICATION, INITIAL RECOGNITION AND MEASUREMENT Investments in financial instruments consist principally of government bonds, commercial papers, stock certificates and treasury bills. Because these financial instruments are readily negotiable, the need for their physical protection and for strong internal controls is almost as great as in the case of cash. Based on level of ownership and management's intent for holding the investment, investment in equity securities are classified under the following Classifications: A Equity investments at fair value through profit or loss (FVPL); B Equity investments at fair value through other comprehensive income (FVOCI); : C. Investment in associate (or joint venture). 4 —jal Instruments “Chapter 6 - Investments in Financial 1S salient features of IFRS 9 relating tp s sommts in associate OF joint venture are a St gved briefly in the succeeding paragraph This chapter discusses debt investments. Equity inv: scope of IAS 28 and are also discus trading and non-trad) id primarily for ing ey investments in which the enterprise does Not regi ae See tiene fair EM through other comprehensive income belong Regory OF investmenes a gt value through profit or loss (FVPL). These ene A ae 5 cure assets in a properly classified statement ‘of financial position, L are inte measured at purchase price and at reporting date are reported at fair value, The change in fair value during the reporting period Is recognized in profit or loss, tae Equity investments hel Equity investments not held for trading eh ownership trees is not eno to exercise significant influence over the investee are a, hadahiy allan itial recognition, the entity may exercign. ue. On the date of s ention| Io reqooriet ine chonge in the far value through other comprehensive incong In such a case, they are initially recognized at purchase price plus directly attributaye transaction costs. At reporting date, they are measured at fair value, with change , fair value during the reporting period reported as component of other comprehensiy income. The accumulated balance of the holding gains and losses is a component equity in the equity section of the statement of financial position. Investments i this classification are generally classified as non-current assets in a properly classifeg statement of financial position. When the enterprise does not elect to recognize the change in the fair vale of non-trading equity securities in other comprehensive income, then the changeh fair value shall be recognized in profit or loss, and the investments shall be designated as (FVPL). The Irrevocable option to designate non-trading equity securities as either FVPL or FVOCI shall be exercised on the date of initial recognition. Investment in associate, which gives the holders significant influence over the operating and financial policies of the investee are accounted for in the investors Consolidated financial statements using the equity method. Under the equity method, the investments are initially recognized at purchase price plus directy attributable transaction costs. The'investment balance is subsequently affected b the associate's transactions that affect its shareholders’ equity, The investors Proportionate share in profit (adjusted for amortization of difference between cost! investment and underlying equity that affect measurement of profit or loss) and tte investor's proportionate, share in other comprehensive income increases te enti inve sha is ( pro scochapter 6 - Investments in Financial Instruments istics of U aerate a the Nnanca asset. The business model adopted by the enterprise ‘pol investments, Such business model may be any of the following: he object! (a) ie vee is to hold the assets to collect contractual cash flows that ly payment for principal and interest (SPPI): (b) sas oblectve is to hold to assets to collect contractual cash flows and 'Q sell the assets when profit opportunity arises; and (c) the objective is neither 1 nor 2 i trading). (generally to hold the financial assets for __If the business model for the debt investment portfolio is (a) above and the entity does not use the fair value measurement through profit or loss, the debt investments shall be classified as debt investments measured at amortized cost. If the business model for the investment portfolio is (b) above and the entity does not use the fair value measurement through profit or loss, the debt investments shall be classified as debt investments measured at fair value through other comprehensive income. If the business model for investment portfolio is (c), or if the business model is (a) or ( b) and the enterprise elects to measure the assets at fair value through profit or loss, then the debt investments shall be classified as at fair value through profit or loss. The summary of the basic principles for financial assets that are within the scope of IFRS 9 is outlined in the matrices that follow:EQUITY INVESTMENTS ae. eas eae | At Fair Value Through | At Fair Value Tig Other Comprehensive | Profit or Loss ugh Income an | Inclusion C Securities not held for (a) Securities heig for ~~ trading for which the trading : enterprise elects to (b) Securities not held fop recognize change in fair trading for which the value through other enterprise did not elect comprehensive income measurement at fair Value through other comprehensive income, Initial recognition Purchase price plus Purchase price; transaction transaction costs Costs are taken to profit or loss | Measurement after Fair value Fair value initial recognition Amount taken to (a) Unrealized gains and | None other comprehensive | losses income (b) Realized gains and losses, with no recycling to profit or loss (but may | be transferred to Retained Earnings) Amount taken to Dividends that are (a)Dividends that are | Profit or loss Considered return on considered return on | investments. investments | (b) Unrealized and realized |_ gains and losses.t or op Investments in Fj > Hancial Instruments Pa Sipe ee A a mortized Cost At Fair Value | croteh Other x ie Value — mprehensive ugh Profit or | Debt investments) eeome Loss that are held wi edt investments th the business bend are held within i iat | (@) Debt investments ‘ held for tradi of collecting business model of ing contractual cash | Coleetng contractual awn he flows consisting ee and to sell, | business model of | SPPI, and which the | enter ich the collecting contractual enterprise did not ecu elected to | cash flows corisisting elect to measure at | in fa nize the change | SPI and which the fair value fa value through, | enterise elected to other comprehensive | measure at fair value. income (©) Debt investments held within the business model of collecting , contractual cash flows and to sell, and which | the enterprise did not elect to recognize the change in FV through ocl. inal AE purchase price | At purchase price plus | At purciase pees recognition plus transaction transaction costs transaction costs are costs taken to profit or loss. Weasurement | Atamortized cost, | At far value, in 2 two At fair value after initial using the effective | step Ten = oF recognition interest method. | 2S just to fair value through oc. | tana gains and | ‘Dnrealized gains and None | Amount taken to | | irounetaen to | None losses due to change ee ce in fair value, | Soprehensive recycling 0 Pro > me Foss when realized: ue (ae | ame | a) terest revenue, a | ayers revenue ® practicality based (haunts taken [ (a) Interest p) Realized 22, | on nominal interests Dot erty [evenue | gna losses (@%5r, | co) unvesized 8 {b) Realized 925) from ‘curative OCP realized gains and and losseSr including moa" losses. including loss a10arises, Chapter 6 - Investments in Financt jd Arasersennessces, inc ition of imp ingle principle for recognit fg The new IFRS 9 applies 2 Sag cost and at fair Value throbs ‘on debt instruments cassited i t arvent is done in three stages: a it The im comprehensive income. stage 1: Set up an allowance upon inital recognition, based on 12-morth ete credit losses; nize additional amount of impairment), quam of the svar since initial recognition; interest revenue is basa, 4 carrying amount of the asset, before deducting the allowance; fe id impairment loss, ba, i jate amount of allowance an a , base Stage 3: Tei abe credit losses if there is objective evidence of impai interest revenue in subsequent periods is based on net carrying ‘Amount of the debt investments (after deducting the related allowance), See illustrative problem in chapter 4 as an example. Internal Control Procedures « The major elements of adequate internal control over the investment securities focus on the following: : » Separation of duties between the custody of the instruments, the maintenance of accounting records and the authorization of purchases and disposals; » Joint control (of at least two officials) over the investment securities, or the use of an independent outside custodian; > Complete detailed records of all securities owned, and the related revenue from interest and dividends; » Registration of securities in the name of the company; » Periodic, physical inspection of securities by an i it a inepertec ea y an internal auditor or othe! » Preparation of a budget of investment rever ss. . nue; > Formulation and implementation of inv "polici i estmer = 7 Registration of securities in the fame of the One _ a ees od Sales of financial instruments should be authorized by prints aspen hvestment Committee or a designated company off policies ofthe enterprise. If posssig qs SOU be in accordance with establst® investments, a file of authoreo sno the management Prepares a list of author amount of resources, offal getures. TF Investments constitute 2 sgn fidelity bonds, Sharge of investments must carry insurance # Regular internal re Ports shou i ld by We Gains and losses. Debt secitties yee interest pated for the investment ravens st income while equity securities8 - Investments in Rj, . wanciat Instruments agincome. Dividend incon inser ould be recognized when Shou be recognized wh, oo" mre and losses. At yearend, th oe When investrnent vere and interest re sold, they result ng red properly by must be yeasur' Y com| an as: je, Mons. TO achieve this chert the ledger balances wnat anieresments ota ; : wi i ese maintained based on Gabe or tana ene price wt entries that adjust the investment tae paanis. phat. Be soul 9 and recordin« balance must be authorized. foo there is a risk that securiti ; ies may be in misapplied reso ay be lost, st é he tablish barriers over invest emsstated sound. eTHte raniiae voir the joint Control of two or mare compar ofa ea ate dere Nyoty of an independent safekeeping eC One officials, or placing them in the ‘ jan of the in: = Other than th ve asstodi struments, there must be a Suede eon teen of is handled sation by another official or @ designated responsible employee. The count of securities on hand 4 conducted by an it i ede concurrently with the verification of athiy ha mee Sdck ean eebemore, the listing .of investments must be periodically reconcled “vith nt accounting records. Investment i serodically recalculated and verified. bisa ened audit Objectives The auditor's objectives in the audit of investments in financial instruments zeto: + consider internal control aver financial instruments held by the client; + determine the existence of investment ‘and that the client has rights to the instruments; : + determine that all financial instruments held by the entity are reported and ~ transactions affecting the investments are properly accounted for (completeness); : : testabish the proper measurement of investment financial instruments; establish accuracy of the amounts recognized in profit or loss and other comprehensive income relating to investments; and i * determine that the presentation and disclosure adequate. f the investments Is Nit Procedures sactions, the auditor confirms ces abel existence occurrence rove ae aia 3 2 een es entity. confirmations sro be 5 fe ana - I reseenaig assurance that teT@,S> sul res fo canes ‘sy ge The confirmation ould include of ea eres Ment held for the client, a5 Well 25 Pa" or PIInstruments Chapter 6 - Inv ents in Finan \ auditor may consider confirming alt and total amount of investment. te auding sales, purchases, divider wars, during the period with the Drokel: Oto make investment transaction” hte is rey collections as well as who is authorized hake Mrewne ns, an = investment income proceeds are remitted to the instruments, the aug icials keep custody of tor shy ‘tie ind simultaneously. The auc. ult Ih .d count all securities on hai The audi Prep ise sacites simultaneous with the count of cash items helg a concerned company officials. The auditor shall inspect the Securities in the preg," of a dlient’s officer or a trusted employee. Inspected instruments shall be Tete intact and the return must be properly documented. If company offi Comparison of the serial numbers on securities with those recorded in, prior year's audit working papers may reveal any substitution or "borrowing: ; securities. Securities held as collateral for loans should be confirmed by sending request signed by the client but mailed by the auditors with the reply directed ts ie auditor's office. ' To establish completeness of account balances and recorded relate: transactions, a cutoff test is conducted to obtain assurance that all investmer: transactions are recorded in the proper reporting period., Analytical reviay procedures and other substantive tests, such as recomputations of gains and loses are applied to help determine whether recorded balances are reasonable. Dividend and interest revenue is usually verified by independet computations by the auditors, or by tests of reasonableness of the amount of revenue eared. Dividend record books published by investment advisory services show te amounts of dividends and dates of declaration, of record, and of payment, 80% interest can be recomputed from the interest rates and Payment dates shown on te bonds. The proper measurement of investments is validated by referring ® nt of yy referring Published price quotations for securities that are measured at fair value. Ir ‘securities do not have published price Quotations, the auditor shall consider obtai”? fot available, the auditors may find It nee eotmeNt: IF such financial stateme”s® ind the unaudited financial statemene Mirsrmmidl perform audit procedures to The auditor shox j aces daceag eee determing whether Investments are proper css statements. In doing so, tor hace nting standards are observed in the fi® auditor has to nent’ Process for classifying securit Obtain an understanding of manage", through other comprehe ites 88 at fair value ‘9 D prehensive i through profit or loss or at fal Vig, profit or loss or at amortized coat ey Cty Securities, or at fair value tous Securities, The client's transvestme! P 62 1ny ut Financial uments the investments, for exay - ting ne for Held to Maturity Sac ysen9 vestment securities classified 25 at et te intention of the man urties), should be questioned as ths sale may a result in reclassification ofthe inve | acquiring these securities; and as ue i a Pou nat De ee 3s at Amortized Cost (or H al estments in debt secures is sol to market interest rates and protean ping a 2 ‘tabill : availability of alternative in gener: vestments and foreign cu $ currency risk. jn determining whether the i san, the autor should determine Tee to impairment to determine the existence of impairment indi ines rape relevant grons specifically related to the security or to a — as adverse “ations, deterioration of the investee’s financial condition, and covoruicae 4 Cae in the fair value of the securities. When indications for impairment exis, 30 & iment loss has to be recognized in profit or loss for in me sat fair value through profit or loss. WOSIISRS: lassified thustrative Working Paper 4 Eauity Investments: ss your audit of the investments held by Rose Company, your client you found the ‘glowing transactions and other information for the year 2018: 2) The financial statements of the company for the year 2017 revealed the following investment balances: Financial Assets at Fair Value through Profit or Loss: ‘nstrument Number of Shares mane Daisy ordinary shares 5,000 r Rosal ordinary share 2,000 60,000 0) You found that the December 31. balances approximated the ek vehi ate Securities, On prt 3, Daisy Company distributed 20% bonus issue ch 30, 2018. dividend declared on Mar ry at P20 per share. at P25 per share 2,000 of Wallng: 4 0 rain m Oeeay aoe wed ri nd_ commissions amounting to pita Ordinary. Rose Pa option nes. gnate the Waling-waling shares "500. The cor 3 mpany exercl ome. atfair value trrough other comprenens Pe a On April 29, Rosal paid P5 cash iG ) On May 15, Rose sold 1,000 of Daisy arin as 973(@) On October 1, Rose sold 500 of Rosal ordinary shares at P37 per share, (h) On December 1, Rosal declared P3 dividend per share on its ordinary payable on January 15 to shareholders of record on December 15, 2517 Sy, (i) Fair values on December 31, 2018 were as follows: Daisy ordinary share i “Rosal ordinary share 2 Waling-waling ordinary share 8 i ities Analysis of Investment in Equity Securit For the Year Ended December 31, 2018 Transaction | Daisy Ordinary Rosal Ordinary Wealing-waling Dividend Gan —> | vr) (vl) (Pv-oc) Treome [om | ON Sale| I # ofsh [Amount | #ofsh | Amount ot cement [iss bal | 5000 pea,000 [000 — | pan,n00 «x | 2018 vy [Transactions Apr. 3 | 1,000 = Apr. 29 P 10,000 May 15 (7,000) | (44,000) P6000 June 1 2,000 P52,500 Oct. 1 (500) (15,000) 3,500 | [Deer 4,500 [ | Dec. 31 before adjustment to Fair Value | 1 5,000 70,000_| 1,500 45,000 2,000 P52,000 P.14,500 P9500 P&L 40,000 7,500 wi [nod (Bee -3t per ee audit $,000 | 110,000 | 1,500 | p52,500 | 2000 | ps6 000 | 14,500 | P9,500 Based on the foregoing working paper, the Rose Ci include ins statement of financial position the following balances: eee In the Statement of Financial Position Current Assets Eauty atts Falr Value through Profit or Loss p62 Non-Current Assets: oreo Comprehenetf ough » 56,000 224casper = Investments in Financia Instruments polders’ Equity snare” unrealized Cumulative Gains on e at Fait Value through Other to” vestments er Comprehensive Income P 4,000 In the Statement of Comprehensive Income or Loss prof Dividend Income Gains on Sale of Equity Investm 14,500 other Comprehensive Income ane 9,500 Cumulative Unrealized Gain on Equity Investments at Fair Value through Other Comprehensive Income P 4,000 g._Debt Investments The Riverside Company engaged your services to examine its financial statements for the year ended Detember 31, 2018. It makes an early adoption of IFRS 9 issued by the IASB in 2017. You identified from the trial balance that its debt investment, consisting solely of ANC 8% Bonds had a balance of P925,250, representing its acquisition cost of P1,084,250 of the P1,000,000 face value bonds, due on December 31, 2022 and net of P159,000 proceeds from sale of the investments. Interest is collectible every December 31. Riverside recorded the interest collected amounting to P80,000 as a credit to Interest Revenue. On December 31, after receiving the periodic interest, Riverside sold P150,000 of the bonds to generate enough funds for settlement of its maturing obligation. The selling price of P159,000 represents the ‘air value of the P150,000 bond investments sold. Because the entity holds these bonds in a portfolio of securities held for collection 2nd also for sale in response to financing requirements, the enterprise elected to designate the debt investments as at fair value through other comprehensive income. ‘our audit staff has calculated an effective interest rate on these investments at 6%, 29d has provided you the following working paper for the computation of the correct ‘amortized cost and interest revenue. Amortization Table Effective | Premium | Amortized —~ Date — ae Nominal | ] ‘Amortization | Cost, End Interest Interest wrtizatio a a 65,055 p14,945 | 1,069,305 —P0,000 (160,396) | __|__ps08,909cial Instruments Chapter 6 - Investments it Solutions: le FV of the full debt investments before sa ieay P159,000/P150,000 = 106%; P1,000,000 x PLEO, Amortized cost of the debt investments ; A 633. Unrealized loss on debt roman 9.305 Unrealized loss recycled to profit or loss: FV ofinvestments old P159,000 Amortized cost of investments sol 1,609,305 x P150,000/P1,000,000 160,396) (1.23% Balance of Unrealized Loss remaining in equity 1X5 The entries that should have been made are as follows: Upon receipt of the periodic interest on December 31: Cash 80,000 Debt Investments at FV through OCI 14,945 Interest Revenue 65,055 To adjust to fair value at December 31, before the sale: Unrealized Gain/Loss on Debt Investments at FV ~ through OCI 9,305 Debt Investments at FV through OCI 9,305 To record the sale: Cash 159, Loss on Sale of Debt Investments ies Debt Investments at Fair. Value ° through OCT Unrealized Gain/Loss on Debt oP Investments at FY through OCI 1,396 Audit Adjustments; (a) Interest Revenue Debt Investments at Fair Value th (b) Unrealized Gain/Loss on FV through Ocr ho Tnvestments = Debt Investments at FV through ocr oe 14,945 rough OCI 4a 930yestnents In ot 6 it! s on Sale of Debt Investments Loss Unrealized Gai @ In/Los at EV through O en Debt Investments fe 1,396 ar ae * Del f ein ng | Unrealized | interest ‘Gain Sakti ot nt ean or Revenue | (Loss) on iss December 31_| 225,250 ess at a s Gift ements P_80,000 | P 0 a effective interest ( 14,945) (14,945) susie fal ; o ‘adjustment to fair (9,305) (0,305) i vave. | ie reecing to profit or 7,396 386) | ‘ess - ; | “galence pet audit P_ 901,000 P7,909 P 65,055 | P (1,396) | snaverside’s financial statements, the following items will be reported: onthe statement of financial position: Non-current assets: Debt Investments at Fair Value through Other ‘Comprehensive Income 901,000 Shareholders’ Equity Cumulative Net Unrealized Gain (Loss) on Debt Investments at Fair Value through wai Other Comprehensive Income nthe statement of comprehensive income: In profit or loss section: seuss Interest Revenue z In other comprehensive INCOME tg Unrealized Loss on-Debt Inves Jed to through OCI, 396 recycle’ 7908 profit or loss ; ‘ancial Instruments Chapter 6 - Investments in Fin DISCUSSION QUESTIONS Discuss the bases for the financial statement classification of cay Y investments. Discuss the bases for the financial statement Classification oF dy investments based on the new IFRS 9. 7 What are the auditor's principal objectives in the audit of finan instruments held by an enterprise as investments? Discuss the internal control procedures adopted by an enterprise fy. investments in financial instruments. Why is it necessary to conduct count of securities on hand simultaneous yt) verification of other liquid assets, such as cash on hand? Compare audit procedures to establish existence of the investments and completeness of recorded transactions when financial instruments are hed internally by company officials and when financial instruments are in the custody of an outside independent entity. What audit procedures shall an auditor Perform to determine whether the securities held by the entity are properly classified in the statement financial position? What factors should ‘an auditor consider in determining whether impairment loss on investments has to be i re financid statements? recognized in th Identify the functions that must be i ements in financial instruments, Segregated with respect to invesChapter 6 - Investments in Financial Instruments MULTIPLE CHOICE securities are held by the company treasurer. A B. _securitie fa @ th seeuites oe held under joint control of at least two officials. D © registered in the name of the ‘security broker. Securities are registered in the name of the company treasurer. 2 eau aoe Conduct the count and inspection of securities held by a ‘ment in the presence of a client's representative in order to A. acknowledge the receipt of securities returned. B. obtain assistance in the physical count and inspection of the securities. C detect switching of securities with other liquid assets of the entity. D. detect forged signatures. 3. The auditors’ count of the client’s investment securities Should be simultaneous with the confirmation of accounts receivable. count of cash balances. count of inventories. confirmation of accounts payable. oOm> 4, Jones was engaged to audit the financial statements of Gamma Corporation for the year ended June 30, 20XX. Having completed an examination of the investment securities, which of the following is the best method of verifying the accuracy of dividend income? Tracing recorded dividend income to cash receipts records and alidated deposit slips. ; . B. Utilizing analytical techniques and statistical sampling. A. c. Comparing recorded dividends with amounts appearing on income the client. 5 See iecordsd dividends with a standard financial reporting zi ic is. services record of dividend (Based on AICPA Question)Instruments se the fair value option rather than amortize 's decision to u: i Say etnte ig most likely to affect which of the following ase te the most? A Completeness B. Existence G Measurement D. Occurrence 6. When a client engages in transactions involving derivatives, the ty should A. develop an understanding of the economic substance of cag derivative. 4 8. confirm with the client's broker whether the derivatives are fy trading purposes. ratify the audit committee about the risks Involved in deriva transactions. : D. add an explanatory paragraph to the auditor's report describing the risks associated with each derivative. (AICPA adapted) 7. Which of the following is the most effective audit procedure for testing the reasonableness of interest income on debt investments? ‘A. Tracing interest declarations to an independent record book. B, Recomputing interest earned, €. Confirming interest rate with the debtor. D. Vouching the receipt and deposit of interest checks. 8. A company holds bearer bonds as temporary investment. Responsibility f = the custody of these bonds and submission of coupons for interest collectors a should be delegated to the ‘A. Chief accountant 8. Company president C. Company treasurer . D. Internal auditor 9. In establishing the existence an 'd ownership of long-term investments in form of publicly-traded securities, an auditor moet likely would A. correspond with the i Owned. tthe investee company to verify the number os B. confirm the num aletocione ber of shares owned that are held by an indeperdé™ G apply analytical pr 3 accounts,» Procedures to the dividend income and invest 230Chapter 6 - Investments in Financial Instruments 10. D. inspect the cash receipts journal for amounts that could represent the sale of securities, a To establish the existence and ownership of an investment in ordinary shares of @ publicly held company, an auditor ordinarily performs a security count or A. determines market share at the end of the reporting period using published price quotation. B. conespons with the investee regarding the number of shares owned. C. relies on the internal control structure if the auditor has tested the controls and has reasonable assurance they are operating as prescribed. ; D. __ confirms the number of shares owned with an independent registrar.EXERCISES Problem 1 Identify by letter the assertions addressed in each of the following Substantive procedures relating to audit of investments: Assertions: mon@p Existence Rights and Obligations Completeness . Valuation and Allocation Presentation and Disclosure Substantive Procedures: yy aay oN . Conduct cutoff test of Confirm balances with the trustee or broker Compare serial numbers of securities with those recorded in prior years’ working papers ; Confirm with banks for investments used as loan collaterals Recompute gains and losses on disposals of investments Verify interest and dividends by recomputations inspect investment securities simultaneous with count of cash on hand balances Obtain fair value from security dealers and from published price quotations Obtain an understanding of Management's process for classifyin investment securities q ae Evaluate information that indicates existence of impairment Purchases and sales als of interest and dividends Of investments and accruES chapter 6 = Investments in Financial Instrument. problem 2 oun ound the ee statements of the Esau Corporation for the year q sti i i 20 at or ss) acca eS the FUL (Ponca Ase at Fair Value Date Particulars it i yan. 3 Purchased 1,000 shares, A Corporation Pe%,000 nex Purchased 1,000 shares, B Corporation 60,000 need Cash dividends, A Corporation : 1,000 5 Sold 500 shares, A Corporation 28,000 8 Purchased 1,000 shares, C Corporation 30,000 8 Purchased 1,000 shares, D Corporation 36,000 july 15 Purchased 200 shares, Esau Corporation 33,000 15 Purchased 500 shares, E Corporation 20,000 Aug 15 Sold 100 shares, Esau Corporation 20,000 Dec. 8 Received 10% bonus issue from E 2,000 Corporation 1,200 10 Cash dividend, C Corporation The following information was discovered from your audit procedures: (2) ‘The Esau Corporation purchased 200 of its own ordinary shares held by a deceased shareholder at P165 per share. 100 of these shares were sold at its market price of P200 per share on August 15. : (b) On December 8, fifty shares of E Corporation were received, Esau credited dividend income equal to the market price of the shares received. © On December 15, D Corporation declared a PS cash dividend per share, payable on January 10, 2019 to shareholders of record as of December 29, 2018. No accrual has yet been taken up by Esau. () The market price of the shares are as follows at December 31, 2018: ‘A Corporation P55 B Corporation 54 C Corporation 32 D Corporation o E Corporationnupier 0 - mvestments in _rinu: REQUIRED: (a) Prepare all audit adjusting entries as a result of the foregoing: (0) Compute the following: (1) Carrying amount of FVPL at December 31, 2018 (2) Gain or loss on the sale of FVPL (3) _ Dividend Income (4) Unrealized gain or loss taken to profit or loss Problem 3 The Investments and Dividends Income accounts of the Honey Company are show below: Trading Securities Date Description z Ref. Debit Credit 6/23/17 5,000 ordinry shares, par value P100, Sugar Co CD—28 520,000 12/31/17 Adjustment to fair value 80,000 5/31/18 500 shares Sugar Co. received as bonus issue GJ-10 12,000 7/10/18 — Sold 1,000 shares @ shares P130 net CR-21 130,000 cCR-40 140,000 12/04/18 Sold 1,000 shares @ P 140. _ Dividend Income Date Description Ref. Debit Credit 5/31/18 Bonus issue (stock dividend) GI-10 12,000 CR-22 20 08/01/18 Cash dividend on Sugar ordinary shares . The following information was obtained during your examination: The December 31, 2017 statement of financial position of Honey Compan! 1. showed, among current assets, Trading Securities of P600,000. You obtained the following information relating to dividends deciaeé ® Sugar Company 2 Type of Diidend Date declared Date of record Date of payment 5a 04/19/18 05/10/18 05/29/18 ve Cosh 06/19/18 o7/igg —o7ysifis. PSI Cash 12/10/18 12/28/18 01/19/19 3. Closing market quotation is P85 as at December 31, 2018:or b= Investments in Fing Instruments pune? te @ Comput () Gain or loss on the July 10 (2) Gain or loss on the Decem ne al (3) Dividend revenue for the year 201 4 ie ae OF oss taken to profit or loss as a result of the Adjusted fi of the investments at December 31, 2018. 2) ‘2nce OF the investment account at December 3, 2018 tO) Audit adjustments at December 3, 1, 2018 problem 4 The Myra Company holds shares in Ivan Company, which it acquired in 2016. You were engaged to audit the financial statements of Myra for the year 2018, and you fund the following accounts in the general ledger: Investment in Ivan Company Debit Credit 0602/2116 3,000 shares at P80 P240,000 10/31/2118 5,000 shares atP 110 550,000 IWI12117 8,000 shares at 100 800,000 0931/2118 4,000 shares at 120 480,000 —_____Investment in Adam Company (831/2118 15,000 Dividend Income (01/02/2118 P53,000° 06/24/2118 75,000 08/31/2118 15,000 TYetransactions of the audit year 2018 are described as follows: ™ IFRS 9 and exercised its option to We ly adoption of classy the ean te at Fair Value thioush. tie oatpralanss Income, The fair value of Ivan Company shares 2 , determined to be P105 per share. December 1, 2017 to shareholders of fing 5 Received a cash dividend (declared 0” etrare, No-entry was made by the Tecord as of January 4, 2018) of P5 P 31, 2017. Company to accrue the dividends at December~~ $n ent int K inanciae Areaee eens May 31 Purchased 4,000 shares at P120 per share. June 24 Received a cash dividend (declared on May 15 to shareholders of recor of June 10) of P5.00 per share. Aug. 31 Received dividend of one share P10 par of Adam Company for ech shares of Ivan Company. The Adam Company had a fair value basey 2 Published price quotation of P16 per share on this date, n Oct. 31 Sold 5,000 shares at P110. Dec. 22 Sold 2,000 shares at P140. Cash was received on January 5, 2019, Dec. 31 Fair values per share are as follows: Ivan; 142; Adams, P17, REQUIRED; Audit adjusting entries Problem 5 At December 31, 2017, White Corp. reported as current assets th \¢ Following equity Securities classified as’at Fair Value through Profit or Loss: Red Corp. 1,000 shares, P200 par convertible 10% preference share P 450,000 Blue Inc,, 6,000 ordinary shares 650,000 Yellow Co., 2,000 ordinary shares $550,000 Trading Securities, at fair value -P1,650,000 On January 2, 2018, White purchased 100,000 of P100 Par ordinary shares of Green Corp. for P16,000,000 representing 25% of Green's outstanding ordinary shares and an underlying equity of P15,000,000 in Green’s net assets at January 2. White had no other financial transactions with Green during 2018, As @ result of White's 25% Ownership of Green, White has the abil ic White had no intention of disposing of the Green Corporation ordinary shares within a Period of 12 months, During 2018, White disposed of the following securities: a. Jan.17 Sold 2,500 shares of Blue for P130 per share, 5. June 1 Sold 500 shares of Yellow, share. after a 10% bonus issue, for P210 pe"Chapter = snvesments in Financia snes 10 shares of Red's yet. 1 Converted 500 shares Red's preference into 1,501 the ei 100 par ordinary, when the market price was P160 Per share for ordinary. is to the shares held by White: The following 2018 dividend information pertain: when the market price of a, On February 14, Yellow issued a 10% bonus Issue, Yellow’s ordinary was P22 per share. il 6 and October 6, i | dividends preference share, to b, On April er 6, Red paid semi-annual ively. Red did not shareholders of record on March 9 and September 9, respectiv pay any dividends on its ordinary shares during 2018. c On June 30, Blue paid a P5.00 per share dividend on its ordinary shares. 4. On March 31, June 30, Sept. 30, and Dec. 31, Green paid quarterly dividends of 52.50 per share on each of these dates. Green's profit for the year ended December 31, 2018, was P10,000,000. Fair values per share of the securities as of December 31, 2018 were as follows Red Corp. ~ preference P460 Red Corp. - ordinary 160 Blue Inc. ~ ordinary 110 Yellow Co. - ordinary 230 Green Corp. — ordinary 175 REQUIRED : (@) Prepare a schedule showing White's investments in financial assets at fair value through profit or loss. (0) Prepare a schedule to show the carrying amount of White's investment in Green at December 31, 2018. (Prepare a schedule showing dividend revenue earned for the the year ended December 31, 2018. (d) Prepare a schedule to compute gains and losses on disposal it of the securities during the year 2018. = (©) Prepare a schedule to com pute the amounts taken to profit or loss as a result of measuring the securities at December 31, 2018. 237 te ,upter_v = invesumeny tr uuese: Problem 6 Your accounting firm was engaged as the auditor of Epson Compan for iy examination of its financial statements for the year ended December 31, 2018, : the course of your review, you gathered the following information: Ih (a) On May 1, 2017, the Epson Company acquired P400,000 of XYZ Corporation bonds for P440,000, inclusive of accrued interest. Interest on bonds i payable semiannually on June 30 and December 31, and bonds Mature December 31, 2022. The XYZ bonds belong to a portfolio of Epson's investments intended for profit taking opportunities, and thus, are held for trading, (b) On October 1, 2018, the Epson Company sold bonds of P100,000 for P109,o9) inclusive of accrued interest. (C) On November 30, 2018, bonds of P120,000 were exchanged for 1,000 shares of XYZ Corporation P100 par ordinary share. Interest was received on the date of exchange. (d) The quoted prices of the securities are as follows: December 31, 2017 XYZ bonds 107 November 30, 2018 XYZ ordinary share _ 140 December 31, 2018 XYZ bonds 108 December 31, 2018 ordinary share 143 REQUIRED: As an audit associate, you were assigned to compute the following: (a) Interest revenue for the years ended December 31, 2017 and Deceme’ 1, 2018. (6) Unrealized gains and losses during years 2017 and 2018. () Gains and losses on disposal of the Investments during 2017 and 208. (d) Carrying value of the investments at December 31, 2017 and Decemo 1, 2018. - “ents in Financigt Jnstrumenty problem 7 on August 1, 2017, Bayleag, 1, : “2yleaf, Inc, pur oe eft ee P57 gS 500 the rest rate f 30 and May 31. The bonds mane Interest ig payables enued ee on May 31, 2029, Inually on November The company intends to collect the : til maturity and d Contractual unti ty and did not exercise 4c Option eo ost OWS from the bond investments value. ‘© measure the debt investments at fair REQUIRED: Compute (a) Interest revenue for years 2017 and 2018, (b) Interest receivable at December 31, 2018. (c) Carrying value of (o om 9 of the investments at December 31, 2017 and December 31, Problem 8 In auditing the books of the Ruby Corporation as of December 31, 2018, before the accounts are closed, you find the investment account balance: INVESTMENT IN PEARL 9% BONDS ( Due date, JUNE 1, 2023) Date Item Debit Credit’ + Balance Jan. 20 Bonds, P500,000 par acquired at 102 plus accrued interest 516,250 516,250 Mar.01 Proceeds from sale of bonds, P 100,000 face and accrued interest 106,000 410,250 dune 04 18,000 392,250 Nov.01 Amount received on call of bonds, P100,000 face, at 101 and accrued interest 104,750 287,500 Dec.01 interest received 13,500 274,000 The investments were held for trading purposes. Pearl 9% bonds were quoted in the Market at 103 at December 31, 2018. 239Chapter 0 - investments if (i REQUIRED : je been made relative to the j (a) Give the entries that should have in bonds, including any adjusting entries that would be made on Dec ha 4 the end of the fiscal year. (b) Give the audit adjustments at December 31, 2018. Problem 9 The following investment account was taken from the general ledger of One Dreay Investment Company: Debt Investments - Fulfilled Dream 6% Bonds (P2,000,000 face Value) (Due December 31, 2023) Date PR Debit Credit Balance January 2, 2018 | VR 1,815,000 June 30, 2018 CRI 60,000 Dec. 31, 2018 CRI 60,000 | Dec. 31, 2018 195,000 | In the course of your examination, you obtained the following information: (a) Interest checks were received on time on June 30 and December 31 ac were credited to the Investment account. (b) One Dream sold P200,000 of its investment on December 31, 2018 fr P 195,000. (©) Effective interest rate on this investment, as computed by your audit sf § 8% (d) One Dream included this investment in a portfolio that is held to collet for sale, and exercised its option to measure them at fair value tre! other comprehensive income, (e) Fair value at December 31, 2018 is 97.5, at December 31, 2019 is 96. REQUIRED : (a, Give the entrié é @ intriés that should have been made relative to the inet in bonds, including any mace yy adjustin, i ould be December 31, the end of the fiscal a that woul () Give the audit adjustments at December 31, 2018. 240@ a amounts and acco, unChapter 6 - Investments in Financial Instruments SUPPLY THE REQUIRED INFORMATION Items 1 through 8 are based on the following information; ‘The investment accounts maintained by Dexter Company were shown below; Equity Investments at Fair Value through Other Comprehensive Income — y Company Ordinary Date Particulars Debit ma | 01/01/18 | Beginning balance, 3,000 shares 36,000 | 01/12/18 | 2 for 1 share split (market price after the | 12,000 share split is P7) 03/18/18 | Sold 1,000 shares at P8 P8,000 7 10/01/18 | Purchased 2,000 additional shares of Y| 17,000 Ordinary at P8 per share plus transaction costs of P0.50 per share 17/30/18 | Sold 1,000 shares at P8.50 8500] 12/31/18 | Adjustment to fair value (FV is P9.20 per 6,700 | share.) mun Nr Financial Assets at Fair Value through Profit or Loss — B Company Ordinary Date Particulars Debit | Credit 06/30/18 | Received a dividend of 1 share of B Company | 1,000 ordinary for every 5 shares of Y Company Ordinary. Market price on this date of B Company Ordinary is P2.50. The shares have par value of Pi. 09/10/18 | Sold 500 shares for P2.80 per share. 1,400 12/31/18 | Adjustment to market; fair value is P3.20 per 2,000 share . Additional Information: * You traced the beginnin: Unrealized Gain or Loss Comprehensive Income 1g balances to your prior year’s workit i year’s working paper. on Equity Investments at Fair Value through Othe! at January 1, 2018 had a credit balance of P6,000: * Upon receipt of the shares as a re li i Toe fam Ey mesa he shares te company oeChapier 0 ~ Avestents in F; PSE Financial struments + The company received oda on Sob 2, ae i ere Cash dj payable to shareholders of rec¢ of Oconee ay record dividends, the company credited dhidend ne + On December 31, 2018, th to Gain on Investment, The oe ividends on Y Company leclared on September 20, . Upon receipt of the cash any credited the adjustments to fair value ordinary and P2,000 on Bs, = a Amount of P8,700 (P6,700 on Y Company Other Operating Income ae He Ordinary) formed part of the balance of comprehensive income, the company's draft of statement of Prepare all audit adjusting entries and compute the following items. The fair value of Y Company Ordinary on December 31, 2017 2 The correct amount of the gain or loss on March 17 sale 3 The correct amount of the gain or loss on November 30 sale 4. The total amount of dividend income on Y Company shares for the year 2018 5. The unrealized gain or loss from the investments above taken as part of other operating income in the profit or loss section of the statement of comprehensive income. 6. The unrealized gain or loss from. the investments above taken as other comprehensive income as a result of the measurement to fair value at December 31, 2018. 7. The amount at which the Equity Investments at Fair Value through Other Comprehensive Income is shown on the December 31, 2018 statement of financial position 8. int at which the FVPL (Financial Assets At Fair Value through Pere ine) be shown on the December 31, 2018 statement of financial position Items 9 through 14 are based on the following information: On tine Company purchased Borlagdan Company, 9% bonds with ah a 54,000,000 for 3,760,000. Kristine Company intends to collect the contractual cash flows from the bonds, and as such the instruments were ignated as Held for Collection and were measured at amortized cost. The effective interest rate on this investment is 10%. The bonds are dated January 1, 2017 andNNN ae Qurw ancial Instruments Chapter 6 - Investments in Financ’ mature on December 31, 2024. The bonds pay tisaee semiannually on June 204 December 31. Kristine’s accounting year is the calendar year. ng 10 of the bonds were sold at 98 piys in Kristine’s business model for this port On November 30, 2019, P1,800,00 rtfolio as at fair value through profit ot interest, As a result of the change I investment, Kristine reclassified the po! The fair value of the bonds was 98 on December 31, 2017, 96 on December x, 2018, and 98% at December 31, 2019. What is Kristine’s interest revenue for the year ended Decembg, x, 9. 2017? 10. At what amount should this investment be presented on December 3, 2017 statement of financial position? 1 What amount of financial asset shall be presented as part of current assets on December 31, 2018 as a result of the above investment? 12. What amount of gain or loss shall be recognized upon sale of the securities at November 30, 2019? 13. At what amount should the investment be shown on December 31, 2019 statement of financial position? 14. How much interest revenue shall be presented in the statement of comprehensive income for the year 2019? Items 15 through 19 are based on the following information On January 2, 2017, Kristine Company purchased Borlagdan Company, 9% bonds with a face value of P4,000,000 for P3,760,000, The bonds are designated a “Financial Assets at Fair Value Through Profit or Loss”: The effective interest raé on this investment {5 10%. The bonds are dated January 1, 2017-and mature ot December 31, 2024. The bonds pay interest: Semiarinually on June 30 and December 31. Kristine’s accounting year is the calendar year. ‘On November 30, 2019, P2,000,000 of the bond: i On eve rnbero 8 is Were sold for P1,960,000 inclusive The fair value of the bonds is 98 on Decem| 018, and 98% at December 31, 2019. er 31,2047, 96 on December 31,2 15; What amount the yeor bra Interest revenue shall be presented in profit or loss fo" 244chapter 6 - Investments in Financial Instruments What amount of unrealized f to profit or loss for 16. the year 2017? gain or loss shall be taken to pr How much gain oF loss would be recognized upon the sale of the securities 17 on November 30, 20197 18. At what amount should the investment be shown on December 31, 2019 statement of financial position? 19. What amount of untealized gain or loss shall be presented in profit or loss for the year ended December 31, 2019? Items 20 through 22 are based on the following information: On April 1, 2018, Power Cast Company acquired a 20% interest in the voting shares of Jacky Chen Company for P1,800,000. The net assets of Jacky Chen on this date were P6,000,000. Power Cast, during 2018, received P100,000 dividends from Jacky Chen Company, which the former credited to Dividend Income. jacky Chen reported profit after income tax of P800,000 during the year, P160,000 of which was earned during the first quarter of 2018. Total fair value of the shares of Jacky Chen held by Power Cast was P2,300,000 at December 31, 2018. Power Cast Company recorded the acquisition of the securities at April 1 by a charge to Investment. Dividends received during the year were credited to Dividend Income and an Unrealized Gain for P500,000 was reported in profit or loss on its draft of statement of comprehensive income for the year 2018. Power Cast had no intention of selling the shares of Jacky Chen, as Jacky Chen is one of Power Cast’s valued suppliers. As a result of this acquisition, Power Cast has the ability to exercise significant influence over the operating and financial policies of Jacky Chen. Jacky Chen's assets and liabilities at April 1, 2018 had fair values approximating carrying amounts, except for land which had fair value of P750,000 more than its @rrying amount, equipment with fair value at April 1 of P200,000 more than their @rrying amounts and inventories which showed carrying values less than fair values te total of 30,000 at April 1. Equipment had a remaining life of 5 years at April 2018, 20. How much total income from investment shall Power Cast recognize for the year 2018 as a result of this investment? 4 How much Dividend Income shall Power Cash report for the year 2018 as a result of its investment in Jacky Chen?Chapter 6 - Investments in Financial Instruments 22. At what amount should this investment be shown on the Decembe, ” 2018 statement of financial position? 7 , Items 23 through 28 are based on the following information The records of Hello Company showed the following entries for its it ‘" ts Nvestineny “Financial Assets at Fair Value through Profit or Loss” account: Date Particulars Debit 2018 bg Jan. 1 Beginning Balances (at fair value) : 1,000 shares — Boracay Company ordinary P 25,000 shares 3,000 shares ~ Bohol Company ordinary shares 18,000 P50,000 par valtie - 8% treasury bonds Purchased 5/1/17, Interest dates — February 1 and August 1 50,000 Jan, 31 Sold 200 shares of Boracay, net of ali commission 6a Feb. 1 Interest on treasury bonds’ 200 June 30 Par value of 20% bonus issue from Bohol Company 4,000 July 8 Sold 300 of Bohol shares, net of commission zee > Aug. 1 P20,000 face value treasury bonds sold at 101 nal - Plus accrued interest - Aug. 1 Interest on remaining treasury bonds Nov. 1 Cash dividend from Boracay Totals Paro Balance P97,000 7 mies. = P-97,000 Dec, 31 Fair values: Boracay Company p30,09 Bohol Company P 7.00 | Treasury bonds 990% 23. How much interest income was ¢ tment) ‘reasury bonds for the year 204g "PY Hello Company on its inves 246chapter 6 = Investments in Financial Instrum rumen: 4. 25. 26. 27. 28. How much is the Gain or loss on the sale of Boracay shares on January 31? How much is the Gain or loss on the sale of Bohol shares on July 8? How much is the gai ” ain or loss on the redemption of Treasury bonds on August How much unrealized gai gain or 2018 as a result of holding gloss habe Sake to profit or loss for the year At what amount should the Tradit tading Securitie 31, 2018 statement of financial postion? Oe neeath a Items 29 through 34 are based on the following information: On December 31, 2017, Daihatsu, Inc. reported as equity investments at fair value through other comprehensive income the following equity securities: Fair Value Cost Alaska Corp., 5,000 ordinary shares (a 1% interest) P110,000 P125,000 Bahamas Corp., 10,000 ordinary shares ( a 2% 160,000 180,000 interest) . Canada Corp., 25,000 ordinary shares (a 10% _700,000 750,000 interest) Total 985,000 1,040,000 Additional information: On May 1, 2018, Alaska issued a 10% bonus issue, when the market price of each share was P24. On November 1, 2018, ‘Alaska paid a cash dividend of P0.75 per share. Daihatsu paid P1,520,000 (at fair value) for 50,000 additional ‘ordinary shares which represented a 20% investment in Canad: ue of all of Canada’s identifiable assets net of liabilities was equal to their carrying amount of P6,350,000. As a result of this transaction, Daihatsu ‘owns 30% of Canada and can exercise significant influence over Canada’s operating and financial policies. . On July 1, 2018, ' shares of Canada Corporation's fa. The fair val Daihatsu’s initial 10% interest of 25,000 shares of Canada's was acquired on Saar 2 2017 for 700,000, At that date, the net assets of Canada totaled 5,800,000 and the fair value of Canada’s identifiable assets net of liabilities was equal to their carrying amount. 47TASS Chapter 6 - Investments in Financial Instruments 29. 30. 31. 33. Market prices per share of the equity securities, all listed on a nationay See, exchange, were as follows: tng December 31 2013 Alaska Corporation - ordinary 23 0C Bahamas Corporation—ordinary 19 Canada Corporation - ordinary 29 Canada reported profit and paid dividends of: Profit Dividend per share Year ended 12/31/17 P350,000 None Six months ended 6/30/18 200,000 None Six months ended 12/31/18 370,000 P1.30 There were no other intercompany transactions between Daihatsu and Canady. Daihatsu has the policy of transferring to Retained Earnings the Unrealzag Gains and Losses relating to equity securities disposed of. What is the balance of the Net Unrealized Gain or Loss on Equity Investments a Fair Value through Other Comprehensive Income at December 31, 2017? What amount of dividend income shall be presented in the profit or loss secton of the statement of comprehensive income for the year 2018? What amount, if any, should Daihatsu, Inc. report in its profit or loss as Income. from Associate- Canada Corporation for the year ended December 31, 2018? At what amount should the Investment in Associate-Canada Corporation reported in Daihatsu’s December 31, 2018 statement of financial position? At what amount should the Equity Investments at Fair Value be shown of ‘statement of financial position at December 31, 2018? What should be the balance of the Net Unrealized Gains or Losses on Eau Investments at December 31, 20187 | What amount of total income or loss (realized or unrealized) shall be preset in profit or loss as a result of the foregoing transactions?er 6 - Investments in Financial Instruments Items 35 through 40 are based on the following information: pecember 31, 2017, Starbooks, Inc. reported as financi 1 fair value through M ofit or 105s the following marketable quay ee assets at fail pr dinary share, P1 seattle Company ordinary share, P10 par, 2,000 shares 28,400 Grunge Co preference share, P50 par, 1,200 shares 78,000 n analysis of transactions during 2018 relating to the account “Trading Securities” reveals the following: + A.20% bonus issue was declared by Seattle Co. when each ordinary share has a market value of P12 per share. Starbooks recorded the dividend as a debit to investment with a corresponding credit to dividend income at the total market value of the shares received. + Subsequent to the receipt of the bonus issue, 400 shares of Seattle were sold at P12 per share, the proceeds of the sale were credited to the account. +A 10% cash dividend from Grunge Company was received and recorded on ‘January 15, 2018. The said dividend was declared on December 15, 2017. «+ 1,500 ordinary shares of Cobain, Inc. were purchased during 2018 at P21 per share. Broker’s commission of P2,800 was recorded as operating expenses. + 800 shares of Nirvana Co. were purchased on April 1, 2018, for the purpose of affiliation. Nirvana has 4,000 shares outstanding throughout the year. The company does not intend to sell the said shares in the near future. The shares were recorded at the purchase price of P50 per share. Broker's commission of 5,400 was recorded as operating expenses. Nirvana reported profit of P50,000 during the year 2018. * There were no other investments during the year. e as of December 31, 2018 are as follows: Seattle * Market values per shar C ordinary, P14; Grunge preference, P64; Cobain’ ordinary, P21; and Nirvana ordinary P52. count balances per books as of December 31, 2018 are as * Related unadjusted ac 3,200 and Operating Expenses P764,000 follows: Other Operating Income PS: Determine the adjusted balances of the following: 35. Trading Securities at December 31, 2018 38. Total dividend income for the year 2018 37, Investment in Associate as of December 31, 2018 249Chapter 6 - Investments in Financial Instruments 38. Income from Associate for the year 2018 39. Operating Expenses 40. Unrealized Gain or Loss on Trading Securities taken to profit or lossAnia] Instrument, AY (Contributed by ones, CORPORATION Bi mags Corporation, an eng "S20, amended by PME) aluminum alloy wheels, } MY listeg : t se ON the sto merchandise to car acy Sorte oP Wholesale, re ana IS @ dealer of quality the company for the yeas SS ionwide, y2"4 2180 consigns some of ite mation durin cemb Pu Were appointed as auditor of ion 9 he Course oF your audit, 2" 2018. You obtained the following CASH 1, Cash is composed of et and cash in banks or Psa cas” fund carried at an imprest balance of P10,000 2 January 15, 2019 Teplenishment of the petty cash fund shows the - P3,000 various Operatir disbursed in December"? PE°S2S ; P2,000 oF which were incurred and - P2,500 advane f in December.” °f2"S and employees; P1,500 of which were made following: 3. Cash in banks consist of the following: PCI Bank Savings account P320,000 PCI Bank Current account 180,000 BPI Current ( 50,000) Bank-A-Rote Savings Account 130,000 —2580,000 Bank-A-Rote was closed by the Bangko Sentral ng Pilipinas on November 5, 2018. The December 31, 2018 reconciliation statement for PCI Bank Current Account shows outstanding checks of P20,000, P5,000 of which are Payments to suppliers which are unreleased as of year-end. 6. A customer’s check amounting to P20,000 was deposited in Decenriber and returned by PCI Bank marked DAIF. The check was subsequently redeposited in January. The company did not make any entry for the return and redeposit of the check, which was for a sale made on November 15, 2018. RECEIVABLES 1. The allowance for doubtful accounts is maintained at 5% of the past-due cou if sale or e due one month after the date of aise fe ca nas nk yet provided any uncollectible accounts ipment. expense for the year 2018. 251{Lauper 0 - investments In Linun t current customers’ accounts (not yet due) wit 2. Subsidiary ledgers show thal cuttramounts £0 187,000, debit balances prior to adjust eceivable subsidiary ledgers reyea) 3. tio accounts receivab : IS that Ls ints rceNvable net ofcredt balances amourting to P15,000, i 4. Past due accounts receivable amounting to P10,250 were found to be fuy ncollectible and should, be written off. 5. Advances to officers and employees of P3,500 were included in the Accounts receivable balance, 6. Notes receivable on December 31, 2018 consists of the following: * 60-day, 16% note dated November 25, 2018 from Toyo ka Motor Corporation, P40,000; ; . 120-day, 20% note dated October 10, 2018 from Iyon-day Moto P75,000; # one-year non-interest bearing note dated June 1, 2018 from Nitso. bishi Motors, P180,000; . . 2-year non-interest bearing note dated March 1, 2018 from the president of A-Mags, P120,000. 7. On June 1, 2048, the company sold aluminum wheels having a cash price of P150,000 to Nitso-bishi Motors. The company accepted a one-year non-interest bearing note as payment for the aluminum wheels. 8. The note from the president of A-Mags was for a loan. Imputed interest at 12% compounded annually was deducted and credited to Interest Income and the proceeds, P95,663, were paid in cash to the President. INVENTORIES 1. The company uses the periodic inventory method of accounting for its inventors 2. Physical count of all inventory in the Premises show a total cost of P1,280,000- 3. Review of records and documents show; @. P100,000 worth of merchandise were receiv the ‘ed and recorded during Period Jan. 1-15, 2019. P40,000 of these were shipped by suppliers prior © December 31, 2018. Of those shipped prior to December 31, 2018, P17,50 were shipped FOB Destination while th sipping pati '@ rest were shipped FOB Ship?. eer so18 pay corded in December, 2018 were shipped only in customers) as of December Sool ce were already collected (paid PY 7 LE FeaaGe pein and sold at 120% of cost were shipped during . P64,000 of f these merchandise are in transit as of December 31, 2018. All shipments are made FOB Shipping Point. d, There were merchandise out on consignment as of December 31, 2018 were” 182,000 (cost). Subsequent remittance reports of the consignees received in January, 2019, show that 60% of these were sold during December at 125% of cost. Consignees are entitled to a commission of 5% of cost. e. There were goods damaged by flood in 2018 and deemed unsalable with no scrap. The goods costing P28,000 are still carried in the books at their original cost. The goods were insured and the company was able to recover 80% of the total cost from the insurance company in February, 2019. f, Purchase of equipment P15,000, on July 1, 2018 was debited to purchases. Said equipment has a useful life of 5 years with no salvage value. INVESTMENTS IN EQUITY SECURITIES Analysis of the account shows the following: Jan. 1, 2018 (Beginning balance) P 89,000 January 1 280,000 March 30 12,000 May 2 ( 16,800) October 1 45,000 December 31, 2018 409,200 The costs of the investments were as follows: San Miguel = Ordinary 500 shares P 27,000 Asia Brewery — Ordinary 1,200 shares sen La Tondefia — Preference 800 shares The total fair values, based on published price quotation on December 31, 2017 are as follows: San Miguel P a Asia Brewery 17,800 La Tondena P 39,000 Total : On Ji the company purchased 30,000 shares of Johnnie Walker Go. for P260-000. 18, te res represent a 25% interest in Johnnie Walker Co The net assets of Johnnie Walker Co. at the time of investment were P1,000,000. The Johnny Walker Co. reported profit of P600,000 in 2018. A- 253Chapter 6 - Investments in Financial Instruments Mags, because of the acquisition, acquires significant influence ove, Sohn Walker Co. is On March 30, the company received 400 shares from La Tondena Were gy at P30 per share. The shares represent a 50% bonus issue, 5. On May 2, the company sold 400 shares of Asia Brewery-Ordinary for P42 ie share 6. On October 1, the Company bought 2,500 shares of A—Mags Corporation Ordinary at Pig Per share, 7. Cash dividends received during the year are as follows: San Miguel ~ Ordinary (June 1, P10/share) P 5,000 Asia Brewery - Ordinary (October, P5/ share) 4,000 J. Walker Co — Ordinary (December 1, P1/share) 30,000 39,000 8. The fair values as of December 31, 2018 are as follows: 7 A~ Mags Corporation P 17 per share | San Miguel — Ordinary P 50 per share ; Asia Brewery — Ordinary P 38 per share ‘ La Tondena ~ Preference P 31 per share J. Walker Co - Ordinary P 8 per shareChapter 7 ; NON-CURRENT OPERATING ASSETS EXPECTED LEARNING OUTCOMES after reading this chapter, you should be able to (2) _ distinguish the different financial statement classifications of non current operating assets; 0) identify internal control procedures relating to operating assets; (c)__ State the auditor's principal objectives in the audit of non-current ‘operating assets and related amounts taken to profit or loss and other comprehensive income; @ apply audit procedures to establish management's assertions on non-current operating assets and related income and expenses; (@ prepare working papers to establish correct balances of non current operating asset accounts and related income and expenses; non-current (f) formulate audit adjustments to bring non-current operating asset accounts and related income and expenses to correct balances; and (g) evaluate the appropriateness of the presentation of investments financial statements. and related income and expenses in the The Different Non-Current Operating Asset Classifications sets include the classifications Property, Plant and and for agricultural industries, Biological Assets. includes tangible assets with a useful life of more than one year, that are held for use in the production or supply ‘of goods and services, for rental to others, or for administrative purposes. The major subgroups are land, buildings, machinery, equipment, land improvements, and natural resources. Non-current operating as Equipment, Investment Property, The title "Property, Plant and Equipment by the lessee under 2 Land or building, or both, held by the owner or by finance lease to earn oe or for capital appreciation, oF both rather than for use "" the producti cipply of goods ar services OF for administrative purposes oF ‘sale in the DE Oe business, are presented on the face ‘of the statement 4F financial position under the heading “nyestment Property A hout physical Intangil ts are Identifiable non monetary assets with physica Substance, uae the enterprise has ‘economic control and from which economic 759Chapter 7- Now: Current operating Assets e form of revenue f; 5 in th pected to the entity in ‘ benefits are expactes Soot avings and other Dare eile fron wn 7 oducts or Service, tents, copyrights, narks, a oftware, motio , | Similar in substance and nature. bee il d_ animals, ine i are living plants an a Biological Aste biological assets are cattle, pigs, bushes, trees a) si Agriculture. Examp! it trees. Under IAS 16 Property, Plant ang Fup é fruit : ina plantation forest, an is expected to bear agricultural produce f, and IAS 41, a living plant that is exp f being sold as agricultural yy," i has a remote likelihood o! 0 Lal pro than one period ae rap sales, are technically called “bearer plants” ang ba except for incidental’ sc i cally : to the classification Property, Plant and Equipmet. Audit Objectives In the audit of non-current operating assets, the auditors’ objectives are to: -consider internal control over non-current operating assets; ¢ substantiate the existence of recorded non-current operating assets; * substantiate the rights and obligations relating to these assets; * establish the completeness of recorded non-current operating assets; determine the correctness and accuracy of the recorded depreciation Or amortization of, and other items affecting profit or loss relating to, non-current operating assets; £ * determine that the measurement of non-ct isi current oper accordance with accounting standards; and pa te gee I) * determine that the Classificatior i is st current Operating assets is appro ieceie ae Although th Property pee is eae are large, the audit work required to verify sone on the engagement, This ea aller proportion of the total audit time assets and relati t rom the low i is i "el Few transactions that affeey teaser tee Internal Control Procedures c ; ontrols over non-current operating One of the most j MPortant inter Of authorization fo " 2Cdulstion of, expenditures for, a assets is the system al ion fo Jenpf EY col crating Assory of these assets, A 9? 4g, which does ni reetod th a, ot my lat achieve Ne put als0 compares achysi’cuthorize aaiusion, coeur and a i ee peso amounts tm expenditures and oy os disclosure and analjig pital budgeting requires and realized with ie of variances by @ reporting procedure a 'S between authorized expenditures ixing accountability and responsibil ity for units of operating assets leads y iit it usage and maintenance of the assets, Once re . Fixin' : intability is v ; jshed, appropriate records for cust 9 ti - fod eo fciates asset utilization Saher, pe) as ae erie maintained. ent. ‘An enterprise shall, likewise estab Hl |, likewi lish and maintain id ach = Sa a Operating assets, This ensures ti uae Deere vst a 19 ere er fecondltg gains and losses on disposals of zssets, preparing tax returns, filing insurance claims, monitoring expenditures for repairs and maintenance and review of estimated useful life. Physical transfers of fixed assets (say, from one department to another or sansfer from the enterprise for use in special projects) shall be documented. It is the responsibility of the department head to ensure that all members of company personnel under his supervision adhere to ‘policies and procedures regarding off- campus use of fixed assets and transfer of fixed assets from one department to another. lish and implement appropriate policy requiring that purchases of long-lived assets be made through normal purchasing procedures. This ensures that the enterprise considers prices quoted by different suppliers, quality, and other features of the asset being purchased. ‘An enterprise shall also estab! Each department head shall submit an annual fixed asset report to the company’s property custodian. The report shall contain, among others, a list of full inventory of fixed assets maintained by the department at the end of the wtiod, major and minor acquisitions, interdepartmental transfers, disposals made dung the year and recommendations for repalrs Or replacements. ie likewi tained on assets with very Insurance and warranties must likewise be main i Soniticant cost of acquisition. A system of serially numbered retirement ‘isons and actions must likewise be in place. A Udit Procedures operating assets is to verify current to auditing non-n e current period. In the case The auditors' approach wus (acquisitions and rere ed biological assets, care must be ment measur‘ at fal ite. Shen nr eeper ea fr value atte FePOTuNS aa4 Ss \ uty Chapter 7 - Non-Current Operating Assets The auditor shall consider the internal control procedures adopt client for fixed assets, particularly those controls relating to expenditures y) te and subsequent to acquistions, accountability and utilization, safegyart “le assets, and information on the assets. "0 of To establish beginning balances of non-current operating assets of 4 client, the auditor may conduct historical analysis of the accounts, tn engagements, the auditors can concentrate on additions, depreciation Mt amortization, change in fair value and retirements during the year under aug, To determine that long-lived assets are controlled by the client, the audits examine invoices, deeds, and title insurance policies. Current property tax bile, fre insurance policies, rent receipts from lessees, and mortgage payments for the yea, and lease contracts must likewise be examined. .Auditors usually make a physica inspection of property acquired during the year. Physical verification of non-monetary assets is the responsibility of the Management to ensure that the assets are in actual existence. The auditor shap, however, verify that physical inspection is conducted by an employee or an outsider with the necessary qualifications. In some instances, however, actual physical inspection and verification may not be practical, especially so, when the assets are in continuous use in production or for provision of service. To test the mathematical accuracy of non-current operating asset records, the auditor obtains from the client a schedule, which includes beginning balances, additions, depreciation and amortization, disposals and ending balances. The auditor should reconcile the beginning balances with the balances in the prior year’ financial statements and should be alert for all new assets that may represent unrecorded additions and for assets that have been removed. The charges for repair and maintenance expense’ must likewise be analyzed to determine whether the costs are properly treated as expenses rather than capitalized. Other subsequent expenditures relating to long-lived assets must be reviewed to determine whether they are appropriately capitalized or expensed. A? error in recording these expenditures will affect not only the reported profit during tHe period of expenditure but also the profit in the subsequent period. The auditors often perform the following audit procedures to locate unrecorded retirements of plant and equipment and investment property: Determine whether old equipment was traded in or replaced by the new units: Analyze the Miscellaneous Revenue account to locate cash proceeds from the sale of retired assets; Investigate retirements related to any discontinued product lines or servicesi > Make inquiries of executives and supervisors tegarding retired assets; 262