CHAPTER

14
14-1.

SUBSTANTIVE TESTS OF
LIABILITIES

a.

Accounts receivable – the auditor’s objective is to test the existence of
accounts receivable.
Accounts payable – the auditor’s objective is to test the completeness of
accounts payable.

b.

Accounts receivable – In selecting accounts for confirmation, auditors focus
on a variety of characteristics, including
 high-volume vendors.
 high-value accounts.
 accounts significantly smaller than in a previous period.
 small or zero-balance accounts.
Accounts payable – In selecting accounts for confirmation, auditors focus on
large, small, or dormant accounts and on vendors the client starts using
around year end.

14-2.

c.

Basic information included on the confirmation requests is the same for
accounts receivable and for accounts payable.

d.

Procedures for mailing are substantially the same for accounts receivable and
for accounts payable.

e.

For accounts receivable, an auditor examines documentary evidence that
indicates the customer was shipped goods and ultimately paid for them. For
accounts payable, if the objective of the confirmation process is to test the
existence of a payable and the vendor does not respond, the auditor should
attempt to verify existence of the liability by performing tests such as
examining the purchase order, the receiving report, and the vendor’s invoice
for the transaction. If the objective is to test completeness, the auditor should
reconcile accounts payable or reconcile to subsequent payments.

a.

The auditor should perform the following procedures:
 Trace balance per confirmation request to confirmation of the supplier /
creditor.
 Trace balance per general ledger to subsidiary ledger.
 Trace payments made to cash payments journal and paid checks.
 For invoices not received at December 31, 2006, determine invoice date.


14-2


Solutions Manual to Accompany Applied Auditing, 2006 Edition




14-3.

For goods shipped FOB destination, examine invoice to determine terms.
For goods shipped FOB shipping point, examine shipping document.
Ask client to explain unlocated differences, and then follow up to
determine that the client’s explanation was valid.

b.

For accounts not confirmed, the auditor should substantiate that a shipment
was received by examining the receiving report, the invoice copy, and
subsequent payment if possible.

c.

The accounts payable clerk should not routinely perform the reconciliation of
monthly statements to the listing of accounts or vouchers payable. Whether
the accounts payable clerk or another employee performs the activity, the
auditor must substantiate the validity of the explanations.

a.

The accounts payable audit procedures should be directed toward searching
for proper inclusion of all accounts payable (completeness) and ascertaining

that recorded amounts are reasonably stated (valuation), because the primary
audit purpose is to reveal any possible material understatements. The
principal objectives of the accounts payable examination are
 to determine the adequacy of internal control for processing and payment
of invoices.
 to prove that amounts shown on the balance sheet are in agreement with
supporting accounting records.
 to determine that liabilities existing at the balance sheet date have been
recorded.

b.

Tan is not required to use accounts payable confirmation procedures. Unlike
accounts receivable, accounts payable require no opinions as to valuation.
The auditor is required to obtain direct confirmation of accounts receivable,
since the primary audit test is for possible material overstatements and the
client usually has available only internal documents, such as sales invoices.
For accounts payable, the auditor can examine external evidence, such as
vendor invoices and vendor statements that substantiates the accounts payable
balance. Although not required, accounts payable confirmation procedures
are often used. The auditor might consider using them when
 internal controls are weak.
 the company is in a tight cash position, and bill paying is slow.
 physical inventories exceed general ledger inventory balances by
significant amounts.
 certain vendors do not send statements.
 vendor accounts are pledged by assets.
 vendor accounts include unusual transactions.



Substantive Tests of Liabilities

14-4.

14-3

c.

A selection technique using the large peso balances of accounts is generally
used when the primary audit objective is to test for overstatements (e.g.,
accounts receivable audit work). Accounts with zero balances or relatively
small balances would not be subjected to selection under such an approach.
When auditing accounts payable, the auditor is primarily concerned with the
possibility of unrecorded payables or understatement of recorded payables.
Selection of accounts with relatively small or zero balances for confirmation
is the more efficient direction of testing since understatements are more likely
to be detected when examining such accounts. When selecting accounts
payable for confirmation, the following procedures could be followed:
 Analyze the accounts payable population and stratify it into accounts
with large balances, accounts with small balances, and accounts with
zero balances.
 Use a sampling technique that selects items based on criteria other than
the peso amount of the items (e.g., select based on terminal digits, select
every nth item based on predetermined interval, etc.).
 Design a statistical sampling plan that will place more emphasis on
selecting accounts with zero balances or relatively small balances,
particularly when the client has had substantial transactions with such
vendors during the year.
 Select prior-year vendors that are no longer used.
 Select new vendors used in the subsequent period.

 Select vendor that do not provide periodic statements.
 Select accounts reflecting unusual transactions during the year.
 Select accounts secured by pledged assets.

a.

The fact that the client made a journal entry to record vendors’ invoices that
were received late should simplify the CPA’s test for unrecorded liabilities
and reduce the possibility of the need for a further adjustment, but the CPA’s
test is nevertheless required. Clients normally are expected to make
necessary adjustments to their books so that the CPA can examine statements
that the client believes are complete and correct. If the client has not
journalized late invoices, the CPA is compelled to substantiate what
ultimately will be recorded as an adjusting entry. In this examination, the
CPA should test entries in the 2004 voucher register to ascertain that all items
that – according to dates of receiving reports or vendors’ invoices – were
applicable to 2006 have been included in the journal entry recorded by the
client.

b.

No. The CPA should obtain a letter in which responsible executives of the
client’s organization represent that to the best of their knowledge all liabilities
have been recognized. However, this is done as a normal audit procedure to
afford additional assurance to the CPA; it does not eliminate the need to
perform his or her own tests.


14-4


Solutions Manual to Accompany Applied Auditing, 2006 Edition
c.

Whenever a CPA is justified in relying on work done by an internal auditor,
he or she should curtail (but not eliminate) his or her own audit work. In this
case, the CPA should have ascertained early in the examination that Oracle’s
internal auditor is qualified by being both technically competent and
reasonably independent. Once satisfied on these points, the CPA should
discuss the nature and scope of the internal audit program with the internal
auditor and should review the working papers so that the CPA may properly
coordinate his or her own program with that of the internal auditor. If the
Oracle internal auditor is qualified and has made tests for unrecorded
liabilities, the CPA can perform only a brief test in this audit area.

d.

Work done by an auditor for a government agency will normally have no
effect on the scope of the CPA’s audit, since the concern of the government
auditors is usually limited to matters unrelated to the financial statements.
Nevertheless, the CPA should discuss the government auditor’s work program
with her since there are isolated situations where specific procedures followed
to a satisfactory conclusion by a government auditor will furnish the CPA
with added assurance and therefore permit certain work in a particular area to
be curtailed. However, government auditors are usually primarily interested
in substantiating as valid and allowable those costs that a company has
allocated against specific government contracts or sales to the government;
consequently, there is little likelihood that the auditor for a government
agency would check for unrecorded liabilities at Oracle.

e.


In addition to the 2007 voucher register, the CPA should consider the
following sources for possible unrecorded liabilities:
 Unentered vendors’ invoice file
 Tax returns for prior years, the status of which is still open
 Discussions with employees
 Representations from management
 Comparison of account balances with preceding-year balances
 Examination of individual accounts during the audit
 Existing contracts and agreements
 Minutes of meetings
 Attorneys’ bills and letters of representation
 Status of renegotiable business
 Correspondence with principal suppliers
 Audit testing of cutoff date for reciprocal accounts (e.g., inventory, fixed
assets)

14-5.

d

14-6.

b


Substantive Tests of Liabilities
14-7.
14-8.


a
d

14-9.

Pelagio Corporation

14-5

(P900,000 + P50,000 + P25,000)

Computation of Bonus and Income Tax
(a) Bonus

=
=

10% x P90,000
P9,000

Income Tax =
=
(b) Bonus:
B =

30% (P90,000 – P9,000)
P24,300

10% (P90,000 – B)


Income Tax:
T = 30% (P90,000 – B)
Computation:
B = P9,000 – 0.10 B; B =
T
T
T

=
=
=

P9,000
1.1

=

P8,181.82

P27,000 – 0.3 B
P27,000 – 0.3 (P8,181.82)
P24,545.45

(c) Let B = Bonus; Let T = Income Tax
B = 0.10 (P90,000 – T)
T = 0.30 (P90,000 – B)
Proof: Income Tax
NI bef B & T
B = P6,495
Less: B

T = P25,051.50
Tax rate
Tax
(d) B
T

=
=

0.10 (P90,000 – B – T)
0.30 (P90,000 – B)

B
T

=
=

P5,888
P25,234

Proof: Bonus
NI bef B & T
Less: B
T
Balance

P90,000.00
6,495.00
P83,505.00

x
30%
P25,051.50

P90,000.00
( 5,888.00)
(25,234.00)
P58,878.00
x
10%
P 5,887.80


14-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition

14-10.

Broadwall Corporation
a.

Esteva should apply the following procedures:
1.

Send standard bank confirmation
a. Direct liabilities
b. Security agreements
2. Examine notes for terms, provisions, etc.
3. Review board meeting minutes

a. Authority for transactions
b. Dividends declared
4. Determine compliance with bank loan provisions
5. Consider effects of president’s loans on debt/equity
6. Investigate business purpose of loan
7. Trace loan proceeds to cash receipts records
8. Trace interest and principal payments to cash disbursements records
9. Recompute and verify interest expense and accrual computations
10. Consider balance sheet presentation/disclosure
a. Current/noncurrent portions
b. Assets pledged as collateral
c. Related party
11. Obtain management representation letter
b.

Broadwall’s financial statements should include the following related party
disclosures:
1.
2.
3.
4.

14-11.

Nature of party’s relationship
Description of the transaction
Peso volume of the loans
Amounts due to president and terms of settlement.

Bem, Inc.

Item No.

AJE

1

None

2

Insurance expense
Prepaid insurance

3

None

4

None

5

None

6

Prepaid dues and subscriptions

9,167

9,167

500


Substantive Tests of Liabilities
Dues and subscriptions expense
None

8

None

9

Accounts payable
Inventory

8,400

Legal and professional fees
Accrued legal and professional fees

4,600

Medical expenses
Accrued medical expenses

2,500


Inventory
Accounts payable

5,500

11
12

AJE

13

None (adjustment already made by client)

14

None

15

None (adjustment already made by client)

16

None

17

None


18

None (adjustment already made by client)

19

Machinery and equipment
Accounts payable - others

20
14-12.

500

7
Item No.

10

14-7

8,400
4,600
2,500
5,500

25,400
25,400

None (adjustment already made by client)


AFC Manufacturing
Requirement (a)
It is essential to coordinate the cutoff tests with the physical observation of
inventory. If the cutoff is inconsistent with the physical inventory there can be
significant errors in the income statement and the balance sheet. For example,
assume an inventory acquisition for P40,000 is received late in the afternoon of
December 31, after the physical inventory is completed. If the acquisition is
included in accounts payable and purchases but excluded from inventory, the
result is an understatement of net earnings of P40,000. On the other hand, if the
acquisition is excluded from both inventory and accounts payable, there is an error
in the balance sheet, but the income statement is correct.


14-8

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Requirement (b)
Adjusting Entry
Receiving
Report
#

Description of
Error(s)

Debit
Account


Amount

Credit
Account
Amount

2631

None

2632

Received prior to
year end and not
recorded

Inventory

3,709.16

Accounts
payable

3,709.16

2633

Included in accounts
payable and not
inventory


Inventory

5,182.31

Purchases

5,182.31

2634

Received prior to
year end and not
recorded

Inventory

6,403.00

Accounts
payable

6,403.00

2635

Included in accounts
payable and not
inventory


Inventory

8,484.91

Purchases

8,484.91

2636

None

2637

Title passed prior to
year end and not
recorded

Inventory

7,515.50

Accounts
payable

7,515.50

2638

None


Requirement (c)
Typically errors which have an effect on earnings are most important because of
the importance of earnings to users of financial statements. Receiving report
numbers 2633 and 2635 affect earnings. In addition, these errors are more
important because they represent the recording of part of the entry. If they are not
adjusted, the inventory balance the following year will be understated by
P13,667.22 (P5,182.31 + P8,484.91). For the other three items (receiving report
numbers 2632, 2634 and 2637), the error is less important because they would be
recorded the following year and the account balances would then be proper.


14-9

Substantive Tests of Liabilities

14-13.

Cute People, Inc.
Requirement (a)
Current Liability Section of the Balance Sheet for Cute People, Inc.
Current liabilities
Notes payable
Accounts payable to trade creditors
Accrued salaries and wages
Payroll taxes and deductions withheld
(P15,000 + P30,000 + P3,000)
Income taxes payable
Other taxes payable (P100,000 + P185,000)
Estimated warranty payables (P55,000 + P145,000 - P130,000)

Cash dividends payable (2,500,000 x P0.40)
Accrued interest [(P4,000,000 x .07 x 1/4) + P90,000]
Miscellaneous accruals
Total current liabilities

P 600,000
325,000
145,000
48,000
250,000
285,000
70,000
1,000,000
160,000
50,000
P2,933,000

Requirement (b)
The following items of information were not used in preparing the current liability
section of the balance sheet:
1. Bonds payable were not included among current liabilities, because they
mature in 2010. Interest accrued on these bonds, however, for the period
January 1 - March 31, 2006 (P4,000,000 x 7% x 1/4 year = P70,000) is
included.
2. Notes payable due after March 31, 2007, totaling P2,400,000, were excluded
because they are not due within the next year.
3. The par and market values of the ordinary shares are not used. These items
would be needed to record the stock dividend, but have no impact on current
liabilities.
14-14.


Pine, Inc.
Requirement (a)
The following additional information is needed to determine the proper lease
classification as financing or operating:
1. The fair value of the building space as of the date on which the lease
agreement was signed.


14-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition
2.

The initial lease term and whether a bargain purchase or renewal option is
available at the end of the term.
3. The estimated useful life of the property.
4. Whether the quarterly lease payments include provision for executory costs
(insurance, taxes, etc.)
5. Whether the residual value is guaranteed by Pine
Requirement (b)
The following auditing procedures should be applied in gathering the information
meeting the requirements set forth in (a) above:
1. Examine the lease agreement for details surrounding the initial lease term,
payment of executory costs, and the existence of purchase or renewal options.
2. Examine appraisal reports and property tax bills for an indication of fair value
at date of lease.
3. Inquire of management or confirm with lessor as to the estimated useful life
of the property.
Requirement (c)

Pine, Inc.
Obligation under Capital Leases, 2006 
December 31, 2006
1/1/06:

Liability as calculated:
NPV of P150,000 per period for 40 periods
at 3% per period (ordinary annuity)
P3,467,215
4/1/06: Payment:
Interest (3% x P3,467,215) = P104,016
Principal (P150,000 - P104,016)
(45,984)
7/1/06: Payment:
Interest [3% x (P3,467,215 - P45,985)] = P102,637
Principal (P150,000 - P102,637)
(47,363)
9/1/06: Payment:
Interest [3% x (P3,467, 215 - P45,984 - P47,363)]
= P101,216
Principal (P150,000 - P101,216)
(48,784)
12/31/06: Principal balance
P3,325,084
F
Requirement (d)
Audit adjustments:
(1)
Lease Property
Interest Expense


3,467,215
307,869

C
C
C

C


Substantive Tests of Liabilities
Obligation under Capital Lease
Rent Expense
To capitalize financing lease and
reverse rental charges erroneously
recognized as expense.
(2)
Depreciation Expense
Accumulated Depreciation
To record depreciation on leased
assets, assuming straight-line
depreciation and full year policy
concerning depreciation in the year
of acquisition.

3,325,084
450,000

14-15.



T

T

346,721

(3)
Interest Expense
Interest Payable
3% of P3,325,084 (4th quarter interest)

AUDIT LEGENDS:

14-11

Examined lease agreement
Traced to general ledger

346,721

99,753
99,753

C
F

Calculated
Footed


Roehl Wholesale Foods, Inc.
a.

See Exhibit A.1.

b.

This is a capital lease inasmuch as the present value of the minimum lease
payments exceeds 90% of the fair value of the property at the date of lease
signing.

c.

In auditing the Belle lease, the student should identify the following
objectives:
1) Determine that the warehouse exists and that the transaction was
completed in 2006.
2) Establish proper classification of the lease as to capital or operating.
3) Verify proper recording of the lease.
4) Ascertain validity of the quarterly payments and determine that they have
been correctly classified as to interest expense and principal reduction.
5) Determine proper authorization of the lease transaction.
6) Verify terms of the lease, i.e., initial lease term, explicit interest rate,
quarterly lease payments and dates of payment, responsibility for
executory costs, and absence of contingent rentals.


14-12


Solutions Manual to Accompany Applied Auditing, 2006 Edition
d.

See Exhibit B.1.

Exhibit A.1.
Belle Warehouse Lease
Amortization Schedule
December 31, 2006
(1)

(2)

Period

Cash-credit

Interest
Expense-debit
[2% x (4)]

1/2/06
1/2/06
4/1/06
7/2/06
10/1/06
1/2/07
4/1/07
7/1/07
10/1/07

1/2/08
4/1/08
7/1/08
10/1/08
1/2/09

P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000
P150,000

C

P80,708
P79,322
P77,908
P76,467
P74,996
P73,496
P71,966
P70,405

P68,813
P67,189
P65,533
P63,844

(3)
Obligations
under Long-term
Lease-debit
[(1) – (2)]
P150,000
P69,292
P70,678
P72,092
P73,533
P75,004
P76,504
P78,034
P79,595
P81,187
P82,811
P84,467
P86,156

Calculated as follows:
Net present value of an annuity due of P150,000
per period for 40 periods at 2% equals P4,185,388.

(4)
Lease

Liabilitybalance
[(4) – (3)]
P4,185,388
P4,035,388
P3,966,096
P3,895,418
P3,823,326
P3,749,793
P3,674,789
P3,598,285
P3,520,251
P3,440,656
P3,359,469
P3,276,658
P3,192,191
P3,106,035

C


14-13

Substantive Tests of Liabilities

Exhibit B.1.
ROEHL WHOLESALE FOODS, INC.
Belle Warehouse
Obligation Under Long-Term Lease
December 31, 2006


Date

Description

1/2/06
1/2/06
4/1/06
7/1/06
10/1/06
12/31/06

Belle warehouse
lease
Initial payment
Payment
Payment
Payment
Accrual

12/31/06

Audited Balances

12/31/06

12/31/06

Cash-credit

Lease

Obligation
debit

^

Interest
Expense

Interest
Payable

P4,185,388 E &
P4,035,388
P3,966,096
P3,895,418
P3,823,326
---------------

P
P
P
P

P3,823,326

P314,405

P76,467

To WP P


To WP R

To WP R

Balance per Ledger

P3,585,388

P

P

AJE 1

P 237,938

P314,405

P76,467

Balance per Audit - as above

P3,823,326

P314,405

P76,467

P150,000 @

P150,000 @
P150,000 @
P150,000 @
P
0

P150,000
P 69,292
P 70,678
P 72,092
-------------

C
C
C
C

AJE 1
Interest expense
Interest payable
Obligation under long-term lease
To adjust obligation for interest not
recognized in lease payments.
@
E

Lease
Obligation
balance


Examined canceled check.
Examine lease agreement and
recalculated net present value
of minimum lease payments.
Also inspected warehouse.
Determined that this is a capital
lease. NPV of lease payments
equals P4,185,388, the fair

80,708
79,322
77,908
76,467

0

C
C
C
C

P76,476

0

314,405
76,467
237,938

Lease Terms:

Term: 10 years with no purchase
or renewal option.
Payments: P150,000 per quarter
payable in advance.
Executory costs assumed by lessee.
Interest rate: 8 percent per annum.
Market value of warehouse:


14-14

Solutions Manual to Accompany Applied Auditing, 2006 Edition

C
&

14-16.

value of the warehouse at date
of lease.
Calculated.
Examined directors’ minutes to
establish proper authorization
of lease transaction.

P4,185,388.
Date of lease: January 2, 2006
Date of first payment: January 2,
2006


Franda Company
1.

This loss contingency is accrued at the end of 2006 because (a) it is an
existing condition, (b) a loss is probable, and (c) the loss can be reasonably
estimated. The loss is accrued at the most likely amount (P70,000) within the
range of amounts as follows:
2006
Dec. 31

2.

Estimated Loss from Litigation
Estimated Liability from Pending
Lawsuit

70,000
70,000

This loss contingency is accrued at the end of 2006 because (a) it is an
existing condition, (b) a loss is probable, and (c) the loss can be reasonably
estimated. The loss is accrued at the estimated cost of repairs (P200,000) as
follows:
2006
Dec. 31

Estimated Expense from Recall Repairs
Estimated Liability for Recall Repairs

200,000

200,000

The potential lawsuits for injury claims are disclosed in a note to the financial
statements because there is a reasonable possibility that a loss may have been
incurred.
3.

This loss contingency is accrued at the end of 2006 because (a) it is an
existing condition, (b) a loss is probable, and (c) the loss can be reasonably
estimated. The loss is accrued at the minimum amount of the range (P40,000)
because it is not likely that the loss will be less, as follows:
2006
Dec. 31

4.
14-17.

Estimated Loss from Pollution Fine
Estimated Liability from Pollution Fine

40,000
40,000

Because of conservatism, this gain contingency is not accrued but is disclosed
in the notes to the financial statements.


14-15

Substantive Tests of Liabilities


14-18.

#

Assets

Liabilities

Owners’ Equity

Net Income

1

I

I

NE

NE

2

NE

NE

NE


NE

3

NE

I

D

D

4

I

I

NE

NE

#

Assets

Liabilities

Owners’ Equity


Net Income

5

NE

I

D

D

6

I

I

I

I

7

D

I

D


D

8

NE

I

D

D

9

NE

I

D

D

10

I

I

NE


NE

11

NE

I

D

D

12

NE

I

D

D

13

NE

I

D


D

14

D

D

NE

NE

15

I

I

I

I

16

D

NE

D


D

17

NE

D

I

I

18

NE

I

D

D

Boogie Corporation
Reacquisition price (P900,000 X 101%)
Less: Net carrying amount of bonds redeemed:
Par value
Unamortized discount
Unamortized bond issue costs
Loss on redemption

Calculation of unamortized discount—
Original amount of discount:
P900,000 X 3% = P27,000
P27,000/10 = P2,700 amortization per year
Amount of discount unamortized:
P2,700 X 5 = P13,500
Calculation of unamortized issue costs—

P909,000
P900,000
(13,500)
(7,200)

879,300
P 29,700


14-16

Solutions Manual to Accompany Applied Auditing, 2006 Edition
Original amount of costs:
P24,000 X P900,000/P1,500,000 = P14,400
P14,400/10 = P1,440 amortization per year
Amount of costs unamortized:
P1,440 X 5 = P7,200

January 2, 2006
Bonds Payable...................................................................................................................
900,000
Loss on Redemption of Bonds ..........................................................................................

29,700
Unamortized Bond Issue Cost..............................................................................
7,200
Discount on Bonds Payable.................................................................................
13,500
Cash....................................................................................................................
909,000
14-19.

Stargazer Company
Reacquisition price (P300,000 X 104%)............................................................................
P312,000
Less: Net carrying amount of bonds redeemed:
Par value............................................................................................................
P300,000
Unamortized discount........................................................................................
(10,000)
290,000
Loss on redemption...........................................................................................................
P 22,000
Bonds Payable...................................................................................................................
300,000
Loss on Redemption of Bonds...........................................................................................
22,000
Discount on Bonds Payable.................................................................................
10,000
Cash....................................................................................................................
312,000
(To record redemption of bonds
payable)

Cash..................................................................................................................................
306,000
Unamortized Bond Issue Costs..........................................................................................
3,000
Premium on Bonds Payable.................................................................................
9,000
Bonds Payable.....................................................................................................
300,000
(To record issuance of new bonds)

14-20.

Miguel Company

Requirement (a)
Transfer of property on December 31, 2006:
Miguel Company (Debtor):
Note Payable........................................................................................................
200,000
Interest Payable...................................................................................................
18,000


Substantive Tests of Liabilities

14-17

Accumulated Depreciation—Machine.................................................................
221,000
Machine.......................................................................................................

390,000
Gain on Disposition of Machine...................................................................
21,000a
Gain on Debt Restructuring..........................................................................
28,000b
a

P190,000 – (P390,000 – P221,000) = P21,000.
(P200,000 + P18,000) – P190,000 = P28,000.

b

Prime National Bank (Creditor):
Machine...............................................................................................................
190,000
Allowance for Doubtful Accounts........................................................................
28,000
Note Receivable...........................................................................................
200,000
Interest Receivable.......................................................................................
18,000
Requirement (b)
“Gain on Machine Disposition” and the “Gain on Debt Restructuring” should be
reported as an ordinary gain in the income statement.

Requirement (c)
Granting of equity interest on December 31, 2006:
Miguel Company (Debtor):
Note Payable........................................................................................................
200,000

Interest Payable...................................................................................................
18,000
Ordinary Shares...........................................................................................
150,000
Additional Paid-in Capital............................................................................
40,000
Gain on Debt Restructuring..........................................................................
28,000
Prime National Bank (Creditor):
Investment (Trading)...........................................................................................
190,000
Allowance for Doubtful Accounts........................................................................
28,000
Note Receivable...........................................................................................
200,000
Interest Receivable.......................................................................................
18,000
14-21.

Grease Products Company

Requirement (a)
Depot................................................................................................................................
600,000
Cash....................................................................................................................
600,000
Depot.................................................................................................................................
41,879
Asset Retirement Obligation................................................................................
41,879


Requirement (b)
Depreciation Expense........................................................................................................
60,000


14-18

Solutions Manual to Accompany Applied Auditing, 2006 Edition
Accumulated Depreciation...................................................................................
60,000
Depreciation Expense........................................................................................................
4,187.90
Accumulated Depreciation...................................................................................
4,187.90*
Interest Expense................................................................................................................
2,512.74
Asset Retirement Obligation................................................................................
2,512.74**
*P41,879/10.
**P41,879 X .06.
Requirement (c)
Asset Retirement
Obligation.....................................................................
75,000
Loss on ARO Settlement....................................................................................................
5,000
Cash....................................................................................................................
80,000


14-22.

Johnny B. Good Corporation
December 31
1.

No adjustment necessary

2.

Interest Expense (P36,000 X 12% X 9/12)
Interest Payable

3,240

Interest Expense (P12,000 X 8/12)
Discount on Notes Payable

8,000

3.
4.

No adjustment necessary

3,240
8,000