Solution Guide: Property, Plant, and Equipment

Solution Guide Property, Plant, and Equipment NFCPAR-Auditing NFCPAR-Au diting Problems In partial fulfillment fulfillment of the requirements requirements in Auditing and Assurance Assurance Services Services (ACCM (ACCM 451)

ANTONIO, JENNILINE N. | APOSTOL, KYRT RHOLYN S. | ARINES, PHILIP G. ASPE, TOM ALDWIN R. | BEA, PAULENE MAE T. AC42

Submitted to: Marcial C. Paglinawan, DBA, CPA September 2018

NFCPAR- Auditing Problems Solution Guide

Property, Plant, and Equipment

PROBLEM NO. 1 Capitalizable Cost of Machinery

Just Around the Corner Co. acquired a new machine. Details of the acquisition are as follows:

1. Purchase price including VAT

1,568,000

2. Cost of water device to keep machine cool

8,000

3. Cost of safety rail and platform surrounding surrou nding machine

12,000

4. Installation Installati on cost, including site preparation and assembling

20,000

5. Fees paid to consultants for advice on acquisition of the machinery

13,000

6. Dismantling cost of the machine

10,000

7. Repair cost of the machine damaged while in the process of installation

5,000

8. Loss on premature retirement-old retirement-o ld machine

18,000

9. Other non-refundable non-refu ndable Sales tax

13,000

10. Cost of training for personnel personnel who will use the machine

25,000

11. Cost of removing old machine

10,000

Determine the cost of Machinery. a. ₱ 1,476,000 b. ₱ 1,420,000 1,420,000

c. ₱ 1,422,000 d. ₱ 1,644,000 1,644,000

Page 2 of 45


DESCRIPTION


MACHINERY

Purchase price including VAT Cost of water device to keep machine cool Cost of safety rail and platform surrounding surroun ding machine Installation Installation cost, including site preparation preparation and assembling Fees paid to consultants for advice on acquisition of the machinery Dismantling cost of the machine Repair cost of the machine damaged while in the process of installation Loss on premature retirement-old retirement-ol d machine Other non-refundable Sales tax Cost of training for personnel who will use the machine machine

1,400,000 8,000 12,000 20,000

TOTAL

1,476,000

OTHERS

NOTES

(1) (2) (2) (2) (2)

13,000 10,000 5,000 18,000 13,000 25,000 48,000

(3) (4) (4) (1) (4)

NOTES

1. PAS 16, paragraph 16-a: The cost of an item of PPE includes its purchase price, including import duties and non-refundable non-refun dable purchase taxes, after deducting trade discounts and rebates. Since VAT is a refundable purchase tax, it is not included to the cost of the machinery. 2. PAS 16, paragraph 16-b: The cost of an item of PPE includes any cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. 3. PAS 16, paragraph 16-c: The cost of an item of PPE includes the initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located. 4. These These ite items ms are are not not des descri cribe bed d by PAS 16, paragraph 16 “components of the the cost of an item of PPE”. Therefore, these items are not included to the cost of the machinery.

Page 3 of 45



PROBLEM NO. 2 Old building will not be demolished

On March 1, 2018, Levy Co., acquired land and building by paying ₱ 6,000,000 and assuming a mortgage of ₱ 1,500,000. The building will be used by Levy Co. as its head office. 1. 2. 3. 4. 5.

Cost of survey Cost of paving parking lot adjoining building Cost of option of the land not acquired Broker’s fee on the properties acquired acquired Cost of relocating and reconstructing the property belonging to others in order to acquire the property 6. Payment to real estate agent 7. Registration Registration fees and transfer of title 8. Title insurance 9. Real Property taxes on the land accrued after acquisition 10. Cost of shrubs, trees, and other landscaping 11. Unpaid real property taxes up to the date of acquisition acquisition 12. Driveway, parking bay, and safety lighting 13. Payment for claim for injuries not covered by insurance 14. Cost of removing trees from the land 15. Salvage value of the timber recovered from the land 16. Renovation cost of the building 17. Payment of medical bills of employees accidentally injured during building renovation renovation

50,000 50,000 7,000 10,000 23,000 40,000 13,000 15,000 5,000 53,000 14,000 19,000 40,000 70,000 5,000 400,000 8,600

REQUIRED: Based on the above data, determine the adjusted cost of the following: CASE NO.1 – Assume Assume that on the date of acquisition, the land and building have fair values of ₱ 6,000,000 and ₱ 2,000,000 respectively.

1. Land a. ₱ 7,790,600 b. ₱ 7,560,000

c. ₱ 7,730,000 d. ₱ 5,690,000

2. Old building a. ₱ 400,000 b. ₱ 2,296,750

c. ₱ 2,357,350 d. ₱ 2,418,750

3. Land improvements a. ₱ 60,600 b. ₱ 61,400

c. ₱ 122,000 d. ₱ 182, 600

Page 4 of 45



CASE NO.2 – Assume that on the date of acquisition, the old building has a minimal fair value.

1. Land a. ₱ 7,790,600 b. ₱ 7,560,000

c. ₱ 7,730,000 d. ₱ 5,690,000

2. Old building a. ₱ 400,000 b. ₱ 2,296,750

c. ₱ 2,357,350 d. ₱ 2,418,750

3. Land improvements a. ₱ 60,600 b. ₱ 61,400

c. ₱ 122,000 d. ₱ 182, 600

CASE 1

1. Cost of survey 2. Cost of paving parking lost adjoining building 3. Cost of option of the land not acquired 4. Broker’s fee on the properties acquired 5. Cost of relocating and reconstructing the property belonging to others in order to acquire the property 6. Payment to real estate agent 7. Registration fees and transfer of title 8. Title insurance 9. Real Property taxes on the land accrued after acquisition 10. Cost of shrubs, trees, and other landscaping 11. Unpaid real property taxes up to the date of acquisition 12. Driveway, parking bay, and safety lighting 13. Payment for claim for injuries not covered by insurance 14. Cost of removing trees from the land 15. Salvage value of the timber recovered from the land 16. Renovation cost of the building 17. Payment of medical bills of employees accidentally injured during building renovation TOTAL

LI

LAND

BLDG

*5,625,000 50,000

*1,875,000

NOTES

50,000 -

(1) (2) (3) (4) (5)

7,500

2,500

17,250

5,750

(5)

30,000 13,000 15,000 -

10,000

10,500

3,500

(5) (2) (2) (4) (3) (5) (3) (6)

-

-

-

53,0000 19,000 -

70,000 (5,000) 400,000 -

-

-

5,833,250

2,296,750

122,000

(2) (7) (2) (6)

Cost allocated to Land:  

   

Cost allocated to Bldg:  

   

Page 5 of 45



NOTES

1. PFRS 3, paragraph 2-b: The acquisition cost of an asset or a group of assets that does not constitute a business shall be allocated to the individual identifiable assets and liabilities based on their relative fair values. The PIC interpretation applies this principle in the allocation of the cost of property to land and building. 2. PAS 16, paragraph 16-b: The cost of an item of PPE includes any cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management should be capitalized as part of the cost of the asset. The example of directly attributable costs presented in PAS 16, paragraph 17 includes “costs of site preparation. 3. Depreciable land improvements not part of the blueprint of the building shall not form part of the cost of the building and shall rather be classified as land improvements. 4. Only the cost of the option of the land acquired shall be capitalized. On the other hand, only unpaid real property taxes up to the date of acquisition assumed by the shall form part of the cost of the land. 5. Since the property was acquired at a single price, the following costs shall be allocated based on their relative fair values. 6. PAS 16, paragraph 16-b: The cost of an item of PPE includes any cost directly attributable to bringing the asset to its intended location and condition. The cost of insurance is charged to the building because it is a necessary and reasonable cost of bringing the building into existence. However, in this instance where claims for damages are not covered by insurance, these should be expensed outright. 7. The salvage value shall be deducted from the cost of the land because this shall be recovered only when sold.

Page 6 of 45


CASE 2

1. Cost of survey 2. Cost of paving parking lost adjoining building 3. Cost of option of the land not acquired 4. Broker’s fee on the properties acquired 5. Cost of relocating and reconstructing the property belonging to others in order to acquire the property 6. Payment to real estate agent 7. Registration fees and transfer of title 8. Title insurance 9. Real Property taxes on the land accrued after acquisition 10. Cost of shrubs, trees, and other landscaping 11. Unpaid real property taxes up to the date of acquisition 12. Driveway, parking bay, and safety lighting 13. Payment for claim for injuries not covered by insurance 14. Cost of removing trees from the land 15. Salvage value of the timber recovered from the land 16. Renovation cost of the building 17. Payment of medical bills of employees accidentally injured during building renovation TOTAL


LAND

LI

BLDG

7,500,000 50,000 10,000

NOTES

-

-

50,000 -

(1) (2) (3) (4) (2)

23,000

(2)

40,000 13,000 15,000 -

(2) (2) (2) (4) (3) (2) (3) (5)

-

53,000

14,000

-

-

19,000 -

70,000 (5,000) 400,000 -

-

-

7,730,000

400,000

122,000

(2) (6) (2) (5)

NOTES

1. Contrary to PFRS 3, paragraph 2-b, in this case, the old building has a minimal fair value which is undeterminable as well therefore, the cost shall solely be charged to the land account. 2. PAS 16, paragraph 16-b: The cost of an item of PPE includes any cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management should be capitalized as part of the cost of the asset. The example of directly attributable costs presented in PAS 16, paragraph 17 includes “costs of site preparation. 3. Depreciable land improvements not part of the blueprint of the building shall not form part of the cost of the building and shall rather be classified as land improvements. 4. Only the cost of the option of the land acquired shall be capitalized. On the other hand, only unpaid real property taxes up to the date of acquisition assumed by the shall form part of the cost of the land. 5. PAS 16, paragraph 16-b: The cost of an item of PPE includes any cost directly attributable to bringing the asset to its intended location and condition. The cost of insurance is charged to the building because it is a necessary and reasonable cost of bringing the building into existence. However, in this instance where claims for damages are not covered by insurance, these should be expensed outright. 6. The salvage value shall be deducted from the cost of the land because this shall be recovered only when sold.

Page 7 of 45



PROBLEM NO. 3 Old building will not be demolished

On March 1, 2018, Levy Co. acquired land and building by paying ₱ 9,000,000 and assuming a mortgage of ₱ 1,000,000. The old building will be demolished for the construction of a new building. 1. 2. 3. 4. 5.

Unpaid real property taxes up to the date of acquisition 14,000 Cost of option of the acquired property 20,000 Excavation cost 12,000 Escrow fees on the properties acquired 11,000 Cost of relocating and reconstructing the property belonging to others in order to acquire the property 23,000 6. Payment to real estate agent 40,000 7. Payments to tenants of the building to induce them to vacate the premises 3,000 8. Legal fees for contract to purchase land 11,000 9. Cost of removing trees from the land 70,000 10. Building permit and licenses 60,000 11. Architect fee 50,000 12. Materials used in all construction 600,000 13. Driveway and walk to building (part of the building plan) 30,000 14. Payment for claim for injuries not covered by insurance 40,000 15. Broker’s fee on the properties acquired 10,000 16. Rental fees generated on the portion of the building being used as a parking site 23,500 17. Cost of paving parking lot adjoining building 50,000 18. Other overhead cost incurred as a result of construction 220,000 19. Service equipment and fixture made a PERMANENT part of the structure 11,000 20. Safety fence around construction site 35,000 21. Removal of safety fence 9,800 22. Demolition cost of the old building 33,000 23. Proceeds from salvage of the demolition 4,000

Page 8 of 45



REQUIRED: Based on the above data, determine the adjusted cost of the following. CASE NO. 1 – Assume that on the date of the acquisition, the land and building have fair values of P 7,000,000 and P 1,000,000 respectively.

1. Land a. ₱ 8,855,875 b. ₱10,202,000

c. ₱ 10, 045,000 d. ₱ 10,265,500

2. The allocated cost of the old building that will be charged to loss. a. Nil c. ₱ 1,378,625 b. ₱ 1,265,125 d. ₱ 1,315,125 3. New Building a. ₱ 1,265,125 b. ₱ 1,077,800

c. ₱ 1,027,800 d. ₱ 1,056,800

4. Land Improvements a. ₱ 13,500 b. ₱ 50,000

c. ₱ 63,500 d. ₱ 113,500

CASE NO. 2 – Assume that on the date of acquisition, the old building is unusable and has minimal fair value.

1. Land a. ₱ 8,855,875 b. ₱ 10,202,000

c. ₱ 10, 045,000 d. ₱ 10,265,500

2. The allocated cost of the old building that will be charged to loss. a. Nil c. ₱ 1,378,625 b. ₱ 1,265,125 d. ₱ 1,315,125 3. New Building a. ₱ 1,265,125 b. ₱ 1,077,800

c. ₱ 1,027,800 d. ₱ 1,056,800

4. Land Improvements a. ₱ 13,500 b. ₱ 50,000

c. ₱ 63,500 d. ₱ 113,500

Page 9 of 45

NFCPAR- Auditing Problems Solution Guide CASE NO.1

1. Unpaid real property taxes up to the date of acquisition 2. Cost of option of the acquired property 3. Excavation cost 4. Escrow fees on the properties acquired 5. Cost of relocating and reconstructing the property belonging to others in order to acquire the property 6. Payment to real estate agent 7. Payments to tenants of the building to induce them to vacate the premises 8. Legal fees for contract to purchase land 9. Cost of removing trees from the land 10. Building permit and licenses 11. Architect fee 12. Materials used in all construction 13. Driveway and walk to building (part of the building plan) 14. Payment for claim for injuries not covered by insurance 15. Broker’s fee on the properties acquired 16. Rental fees generated on the portion of the building being used as a parking site 17. Cost of paving parking lot adjoining building 18. Other overhead cost incurred as a result of construction 19. Service equipment and fixture made a PERMANENT part of the structure 20. Safety fence around construction site 21. Removal of safety fence 22. Demolition cost of the old building 23. Proceeds from salvage of the demolition TOTAL

Property, Plant, and Equipment LAND

OLD BLDG

8,750,000

1,250,000

12,250 17,500

1,750 2,500

NEW BLDG

-

LI

-

(1) (2) (2) (3)

12,000 9,625

NOTES

1,375 2,875

(2) (2)

5,000 375

(2) (2)

20,125 35,000 2,625 11,000

(3)

70,000

(3) (3) (3) (3) (3)

60,000 50,000 600,000 30,000

(4) 8,750

1,250

-

(2) (5)

-

8,926,875

-

1,265,125

-

50,000

(6)

220,000

(3)

11,000

(3)

35,000 9,800 33,000 (4,000)

(3) (3) (3) (3)

1.056,800

50,000

Cost allocated to Land:  

   

Cost allocated to Bldg:  

   

Page 10 of 45



NOTES

1. PFRS 3, paragraph 2-b: The acquisition cost of an asset or a group of assets that does not constitute a business shall be allocated to the individual identifiable assets and liabilities based on their relative fair values. The PIC interpretation applies this principle in the allocation of the cost of property to land and building. 2. Since the property is acquired at a single price, the following costs shall be allocated based on their relative fair values. 3. PAS 16, paragraph 16-b: The cost of an item of PPE includes any costs directly attributable to bringing the asset to the location and condition necessary for its intended use by management should be capitalized as part of the cost of the asset. The example of directly attributable costs presented in PAS 16, paragraph 17 includes “costs of site preparation. 4. PAS 16, paragraph 16-b: The cost of an item of PPE includes any costs directly attributable to bringing the asset to the location and condition. The cost of insurance is charged to the building because it is a necessary and reasonable cost of bringing the building into existence. however, in this instance where claims for damages are not covered by insurance, these should be EXPENSE OUTRIGHT. 5. PAS 16, paragraph 16-b: The cost of an item of PPE includes any costs directly attributable to bringing the asset to the location and condition. HOWEVER , in the this instance, rental fees generated on the portion of the building being used as a parking site shall not form of the cost of the building and it shall shoulder form part of rental income instead.

Page 11 of 45

NFCPAR- Auditing Problems Solution Guide CASE NO.2

Property, Plant, and Equipment LAND

OLD BLDG

NEW BLDG

LI

10,000,000 1. Unpaid real property taxes up to the date of acquisition 2. Cost of option of the acquired property 3. Excavation cost 4. Escrow fees on the properties acquired 5. Cost of relocating and reconstructing the property belonging to others in order to acquire the property 6. Payment to real estate agent 7. Payments to tenants of the building to induce them to vacate the premises 8. Legal fees for contract to purchase land 9. Cost of removing trees from the land 10. Building permit and licenses 11. Architect fee 12. Materials used in all construction 13. Driveway and walk to building (part of the building plan) 14. Payment for claim for injuries not covered by insurance 15. Broker’s fee on the properties acquired 16. Rental fees generated on the portion of the building being used as a parking site 17. Cost of paving parking lot adjoining building 18. Other overhead cost incurred as a result of construction 19. Service equipment and fixture made a PERMANENT part of the structure 20. Safety fence around construction site 21. Removal of safety fence 22. Demolition cost of the old building 23. Proceeds from salvage of the demolition TOTAL

NOTES

(1) (2)

14,000 20,000

(2) (2)

12,000 11,000 23,000

(2) (2)

40,000 3,000

(2) (2)

11,000

(2)

70,000

(2) (2) (2) (2) (2)

60,000 50,000 600,000 30,000

(2) 10,000

-

-

(2) (4)

-

10,202,000

-

NIL

-

50,000

(2)

220,000

(2)

11,000

(2)

35,000 9,800 33,000 (4,000)

(2) (2) (2) (2)

1.056,800

50,000

Page 12 of 45



NOTES

1. Contrary to PFRS 3, paragraph 2-b, in this case, the old building has a minimal fair value which is undeterminable as well therefore, the cost shall solely be charged to the land account.

2. PAS 16, paragraph 16-b: The cost of an item of PPE includes any costs directly attributable to bringing the asset to the location and condition necessary for its intended use by management should be capitalized as part of the cost of the asset. The example of directly attributable costs presented in PAS 16, paragraph 17 includes “costs of site preparation. 3. PAS 16, paragraph 16-b: The cost of an item of PPE includes any costs directly attributable to bringing the asset to the location a nd condition. The cost of insurance is charged to the building because it is a necessary and reasonable cost of bringing the building into existence. However, in this instance where claims for damages are not covered by insurance, these should be expensed outright. 4. PAS 16, paragraph 16-b: The cost of an item of PPE includes any costs directly attributable to bringing the asset to the location a nd condition. However, in the this instance, rental fees generated on the portion of the building being used as a parking site shall not form of the cost of the building and it shall shoulder form part of rental income instead. 5. Depreciable land improvements not part of the blueprint of the building shall not form part of the cost of the building and shall rather be classified as land improvements .

Page 13 of 45



PROBLEM NO. 4 Land, Building and Machinery

The property, plant and equipment section of Yes the Blessings Corporation’s balance sheet at December 31, 2007 include the following items: Land Land improvements Building Machinery and equipment

₱ 2,500,000 560,000 3,600,000 6,600,000

During 2008 the following data were available to you upon your analysis of the accounts: Cash paid on purchase of land Mortgage assumed on the land bought, including interest at 16% Realtor’s commission Legal fees, realty taxes and documentation expenses Amount paid to relocate persons squatting on the property Cost of tearing down an old building on the land Amount recovered from the salvage of the building demolished Cost of fencing the property Amount paid to contractor for the building erected Building permit fees Excavation expenses Architect’s fee Interest that would have been earned had the money used during the period of construction been invested in the money market Invoice cost of machinery acquired Freight, unloading and delivery charges Customs duties and other charges Allowances, hotel accommodations, etc., paid to foreign technicians during installation and test run of machines Royalty payment on machines purchased (based on units produced and sold)

₱ 10,000,000 16,000,000 1,200,000 200,000 400,000 300,000 600,000 440,000 8,000,000 50,000 250,000 100,000 600,000 8,000,000 240,000 560,000 1,600,000 480,000

REQUIRED: Based on the above and the result of your audit, compute for the following as of December 31, 2008: 1. Land 2. Land improvements 3. Building 4. Machinery and equipment 5. Total depreciable property, plant and equipment Adjusted balances: Page 14 of 45



1. Land Description

Land, 12/31/07 Cash paid on purchase of land Mortgage assumed on the land bought, including interest at 16% Realtor’s commission Legal fees, realty taxes and documentation expenses Amount paid to relocate persons squatting on the property Cost of tearing down an old building on the land Amount recovered from the salvage of the building demolished

Land, 12/31/08

Amount 2,500,000 P 10,000,000 16,000,000 1,200,000 200,000 400,000 300,000 (600,000)

Notes

(1) (2) (2) (1) (2) (2) (6)

P 30,000,000

2. Land improvements Description Land improvements, 12/31/07 Cost of fencing the property

Land improvements, 12/31/08

Amount P 560,000 440,000

Notes

(5)

P 1,000,000

3. Building Description

Building, 12/31/07 Amount paid to contractor for the building erected Building permit fees Excavation expenses Architect’s fee

Building, 12/31/08

Amount P 3,600,000 8,000,000 50,000 250,000 100,000

Notes

(1) (2) (2) (2)

P 1,2000,000

4. Machinery and equipment Description Machinery and equipment, 12/31/07 Invoice cost of machinery acquired Freight, unloading and delivery charges Customs duties and other charges Allowances, hotel accommodations, etc., paid to foreign technicians during installation and test run of machines

Machinery and equipment, 12/31/08

Amount 6,600,000 8,000,000 240,000 560,000 1,600,000

Notes

(1) (20 (1) (2)

P 17,000,000

Page 15 of 45



NOTES

1. PAS 16, paragraph 16-a: the cost of an item of PPE includes its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates. 2. PAS 16, paragraph 16-b: the cost of an item of PPE includes any cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. 3. PAS 16, paragraph 16-c: the cost of an item of PPE includes the initial estimate of the cost of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. 4. These items are not described by PAS 16, paragraph 16 “components of the cost of an item of PPE”. These items are not included to the cost of the machinery. 5. Cost of temporary safety fence around construction site and subsequent removal thereof is capitalized to the cost of the building. However, construction of permanent fence after the completion of the building is recognized as land improvement. 6. The demolition cost minus salvage value is capitalized is capitalized as cost of the building whether the new building is accounted for as property, plant and equipment , investment property or inventory

Page 16 of 45



PROBLEM NO. 5 Grants related to depreciable assets

On January 1, 20X1, GUATANTEE REALITY Company received a grant of ₱ 25 million from the France government for the construction of a building that will be used as a laboratory and research facility with an estimated cost of ₱ 30 million and useful life of 20 years. The facility was completed on Januar y 1, 20X2.

REQUIRED: 1. How much income from the government grant should be recognized in 20X2? a. Zero c. ₱ 1,500,000 b. ₱ 250,000 d. ₱ 1,250,000 2. Depreciation expense in 20X2 assuming gross method was used. a. Zero c. ₱ 1,500,000 b. ₱ 250,000 d. ₱ 1,250,000 3. Depreciation expense in 20X2 assuming net method was used. a. Zero c. ₱ 1,500,000 b. ₱ 250,000 d. ₱ 1,250,000 4. Carrying amount of the building on December 31, 20X2 assuming the gross method was used. a. ₱ 5,000,000 c. ₱ 4,750,000 b. ₱ 30,000,000 d. ₱ 28,500,000 5. Carrying amount of the building on December 31, 20X2 assuming the net method was used. a. ₱ 5,000,000 c. ₱ 4,750,000 b. ₱ 30,000,000 d. ₱ 28,500,000

Page 17 of 45



Solutions: NOTES:

1. I ncome from Government Grant 2. Cost of the research facility Divide by: Useful life

Depreciation E xpense

0 30,000,000 20 yrs.

1,500,000

3. Cost of the research facility Deduct: Fair value of the land Net Total Divide: Useful life

30,000,000 25,000,000 5,000,000 20 yrs.

Depreciation expense – 20X2

250,000

4. Cost of the research facility Accumulated Depreciation (30,000,000/20)

Carrying Amount 5. Cost of the research facility Fair value of the land Total Depreciation expense in 20X2 (30,000,000-55,000,000)/20

Carrying Amount

(1)

(2)

(2)

30,000,000 (1,500,000)

28,500,000

(3)

30,000,000 (25,000,000) 5,000,000 (250,000)

13,500,000

(4)

NOTES

1. PAS 20, paragraph 27: One method recognises the grant as deferred income that is recognised in profit or loss on a systematic basis over the useful life of the asset. This explains why no income is recognized yet during the year. 2. PAS 16, paragraph 47: Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost. 3. PAS 16, paragraph 6: The carrying amount is the amount at which an asset is recognized in the statement of financial position after deducting any accumulated depreciation and accumulated impairment loss. 4. PAS 20, paragraph 27: Government grants related to assets, including non-monetary grants at fair value, shall be presented in the statement of financial position either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset.

Page 18 of 45



PROBLEM NO. 6 Grants related to nondepreciable asset

On January 1, 20X1, IT’S THE DAY I’M WAITING FOR Company received a large tract of land in the Ifugao province by the Philippine government. The fair value of the land is ₱ 5 million. IT’S THE DAY I’M WAITING FOR Company mandated by the grant to construct factory in the area and employ only personnel residing in the Ifugao region. On January 1, 20X2, the factory building was finished and the cost of the factory amounted to P20 million with useful life of 10 years.

REQUIRED: 6. How much income from the government grant should be recognized in 20X2? a. Zero c. ₱ 5,000,000 b. ₱ 500,000 d. ₱ 4,500,000 7. Depreciation expense in 20X2 assuming gross method was used. a. Zero c. ₱ 2,000,000 b. ₱ 500,000 d. ₱ 1,500,000 8. Depreciation expense in 20X2 assuming net method was used. a. Zero c. ₱ 2,000,000 b. ₱ 500,000 d. ₱ 1,500,000 9. Carrying amount of the building on December 31, 20X2 assuming the gross method was used. a. ₱ 18,000,000 c. ₱ 20,000,000 b. ₱ 13,500,000 d. ₱ 15,000,000 10. Carrying amount of the building on December 31, 20X2 assuming the net method was used. a. ₱ 18,000,000 c. ₱ 20,000,000 b. ₱ 13,500,000 d. ₱ 15,000,000

Solutions: NOTES:

1. Fair value of the land Divide by: Useful life

I ncome from Government Grant 2. Cost of the factory of the building Divide by: Useful life

Depreciation E xpense

5,000,000 10 yrs.

500,000

(1)

20,000,000 10 yrs.

2,000,000

3. Cost of the factory building Deduct: Fair value of the land Net Total Divide: Useful life

20,000,000 5,000,000 15,000,000 10 yrs.

Depreciation expense – 20X2

1,500,000

(2)

(2)

Page 19 of 45


4. Cost of the factory Accumulated Depreciation (20,000,000/10)

Carrying Amount 5. Cost of the factory Fair value of the land Total Depreciation expense in 20X2 (20,000,000-5,000,000)/10

Carrying Amount

Property, Plant, and Equipment 20,000,000 (2,000,000)

18,000,000

(3)

20,000,000 (5,000,000) 15,000,000 (1,500,000)

13,500,000

(4)

NOTES

1. PAS 20 provides that “grant related to nondepreciable asset requiring fulfillment of certain conditions shall be recognized as income over the periods which bear the cost of meeting the conditions.” 2. PAS 16, “Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.” 3. PAS 16, “Carrying amount is the amount at which an asset is recognized in the statement of financial position after deducting any accumulated depreciation and accumulated impairment loss.” 4. PAS 20, “Government grants related to assets, including non -monetary grants at fair value, shall be presented in the statement of financial position either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset.” PAS 16, “Carrying amount is the amount at which an asset is recognized in the statement of financial position after deducting any accumulated depreciation and accumulated impairment loss.”

Page 20 of 45



PROBLEM NO. 7 Borrowing Costs

You are engaged to audit the accounts of ABC Company. The following disbursements were made in relation to the construction of its building which started January 1, 2015 and was completed December 31, 2015. January 1 March 31 July 1 August 1 December 31

P 10,000,000 5,000,000 6,000,000 3,000,000 1,000,000

1. The client is not sure as to how it should treat the interest related to the above construction. Assuming the building is a qualifying asset, the interest related to the a. capitalized as part of the cost of the building b. charge to expense c. either a or b d. neither a nor b For each of the following independent situations, determine the amount of interest that should be part of the cost of the building. 2. CASE NO. 1: On January 1, ABC obtained a loan for P 20,000,000 at an interest rate of 10% specifically to finance the construction of its building. Prior to disbursements, the proceeds were temporarily investment and earned interest income of P 100,000. a. ₱ 2,000,000 b. ₱ 1,800,000 c. ₱ 1,900,000 d. ₱ 1,700,000 3. CASE NO. 2: ABC had the following borrowing which were partly used to finance the construction of the company’s building: Date obtained January 1, 2014 January 1, 2015

a. b. c. d.

Term 5 years 2 years

Interest Rate 7.5 % 12 %

Amount P 10,000,000 P 20,000,000

₱ 1,890,000 ₱ 1,942,500 ₱ 1,850,000 ₱ 1,845,000

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4. CASE NO. 3: On January 1, ABC obtained loan for P 12,000,000 at an interest rate of 10% specifically to finance the construction of its building. Interest earned from temporary investment of the proceeds amounted to P 100,000. In addition, ABC had the following borrowing, part of which was used for the construction activities: Date obtained January 1, 2014 January 1, 2015

a. b. c. d.

Term 5 years 2 years

Interest Rate 7.5 % 12 %

Amount P 10,000,000 P 20,000,000

₱ 1,792,500 ₱ 1,782,500 ₱ 1,100,000 ₱ 1,730,000

Solutions:

1. A. Note (1) 2. CASE NO. 1: Entity borrows funds specifically for the purpose of obtaining a qualifying asset Notes

Actual borrowing cost (P 20,000,000 x 10%) Less: Interest income from temporary investment

P 2,000,000 100,000

Capitalizable borrowing cost

P 1,900,000

(2)

3. CASE NO. 2: Entity borrows funds generally and partly uses them to purpose of obtaining qualifying asset Date January 1 March 31 July 1 August 1 December 31 Average carrying amount

Expenditures ₱ 10,000,000 5,000,000 6,000,000 3,000,000 1,000,000

Months outstanding 12/12 9/12 6/12 5/12 0/12

Amount ₱ 10,000,000 3,750,000 3,000,000 1,250,000 0 ₱ 18,000,000

Amount of general borrowing Divided by: actual borrowing cost Capitalization rate

₱ 30,000,000 750,000 2,400,000

3,150,000 10.5 %

Notes

Average carrying amount Multiply by: capitalization rate


₱ 18,000,000 10.5 % ₱

1,890,000

(3)

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4. CASE NO. 3 Date January 1 March 31 July 1 August 1 December 31 Average carrying amount

Expenditures ₱ 10,000,000 5,000,000 6,000,000 3,000,000 1,000,000

Months outstanding 12/12 9/12 6/12 5/12 0/12

Amount of general borrowing

₱ 30,000,000 750,000 2,400,000

Divided by: actual borrowing cost Capitalization rate

Specific Borrowing Actual borrowing cost Less: Interest income General Borrowing Average expenditure Less: Specific borrowing Total Multiply by: capitalization rate


Amount ₱ 10,000,000 3,750,000 3,000,000 1,250,000 0 ₱ 18,000,000

3,150,000 10.5 %

₱ 1,2000,000 100,0000

1,100,000

18,000,000 12,000,000 6,000,000 10.5 %

630,000 ₱ 1,730,000

NOTES

1. PAS 16, paragraph 1 states that “borrowings that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset.” 2. PAS 16, paragraph 12 states that “To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investments on that borrowings.” 3. PAS 16, paragraph 14 states that “To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation by applying a capitalization rate to the expenditures on that asset. The capitalisation rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs that an entity capitalises during a period shall not exceed the amount of borrowing costs it incurred during that period.”

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PROBLEM NO. 8 Land and Building

The Blue Corporation was incorporated on January 2, 2008, but was unable to begin manufacturing activities until July 1, 2008 because the new factory facilities were not completed until that date. The “Land and Building” account at December 31, 2008 follows: DATE Jan. 31 Feb. 28 May 2 May 2 June 1 July 1 July 1 Dec. 31

PARTICULARS Land and Building Cost of removal of old building Partial payment of new construction Legal fees paid Second payment of new construction Fire insurance premium – 1 year Final payment on new construction Asset write-up

Dec. 31

Depreciation – 2008, at 1% of account balance

AMOUNT ₱ 1,098,000 60,000 700,000 15,000 600,000 26,000 200,000 500,000 3,199,000 31,990 ₱ 3,167,010

You were able to gather the following: a.

To acquire land and building, the company paid 98,000 cash and 10,000 shares of its 9% cumulative preferred shares, 100 par value per share. The shares were then selling at 120.

b. Legal fees covered the following: Cost of Incorporation Examination of title covering purchase of the land Legal work in connection with construction contract

c.

9,500 4,000 1,500 15,000

Because of general increase in construction costs after entering into the building contract, the board of directors increased the value of the building by 500,000, believing such increase is justified to reflect current market value at the time the building was completed. Retained earnings was credited for this amount.

d. Estimated useful life of the building is 25 years.

REQUIRED: 1. Prepare the necessary adjusting journal entries as of December 31, 2008. 2. Determine the adjusted balances of the following as of December 31, 2008: a. Land and building b. Land c. Carrying value of building d. Organization expense

Page 24 of 45



Adjusting journal entries:

1. Land [(10,000 shares x 120) + 98,000] Land and Building Additional paid in capital

1,298,000 1,098,000 200,000

2. Building Land and Building

60,000

3. Organization expenses Land Building Land and building

9,500 4,000 1,500

4. Building Land and Building

700,000

5. Building Land and building

600,000

60,000

15,000

700,000

600,000

6. Insurance expense (26,000 x ½) Prepaid insurance Land and building

13,000 13,000 26,000

7. Building Land and building

200,000

8. Retained earnings Land and building

500,000

200,000

500,000

9. Land and building Depreciation expense Accumulated depreciation

31,990 760 31,230

Adjusted balances:

AJE no. 1 AJE no. 3

Adjusted balance

AJE no. 2 AJE no.3 AJE no.4 AJE no.5 AJE no.7

Adjusted balance

LAND 1,298,000 4,000

1,302,000 BUILDING 60,000 1,500 700,000 600,000 200,000

1,561,500 Page 25 of 45



Should be depreciation (1,561,500/25 x 6/12) Recorded depreciation

31,230 31,990 760

Overstatement in depreciation expense

Unadjusted balance

LAND AND BUILDING ACCOUNT 3,167,010 1,098,000 60,000 15,000 700,000 600,000 26,000 200,000 500,000 31,990

0

AJE no.3

Adjusted balance

AJE no.1 AJE no.2 AJE no.3 AJE no.4 AJE no.5 AJE no.6 AJE no.7 AJE no.8 AJE no.9

Adjusted Balance

ORGANIZATION EXPENSE 9,500

9,500

NOTES

1. AJE no.1: the cost of the land should include the cash price paid and the fair value of the shares issued. 2. AJE no.2: the cost of demolishing the old building should be capitalized to the new building since the demolition of the old building is a direct result of the decision to construct the new building. 3. AJE no.3: cost of incorporation is not directly attributable to the building or land, so it should be expense. Examination of the title covering purchase of the LAND should be capitalized to the land (legal fees and other expenditures for establishing clean title is part of the cost of land). Legal work in connection with construction contract is part of the new building. 4. AJE no.4, 5, and 7: amount paid for the construction of new building should be capitalized to the building. 5. AJE no.6: insurance paid is for 1 year, we only consumed half of the year, so we should recognize the unexpired part of the insurance.

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PROBLEM NO. 9 Machinery and Depreciation

In the audit of the books of Green Company for the year 2008, the following items and information appeared in the Production Machines account of the auditee:

Date 2008 Jan 01 Aug 31 Sept 30 Dec 01 Dec 01 31

Particulars Balance-Machines 1,2,3, and 4 at ₱ 90,000 each Machine 5 Machine 1 Machine 6 Machines 7 and 8 at ₱ 216,000 each Machine 2 Balance

Debit ₱

Credit

360,000 198,000 3,000 96,000 432,000

___________ ₱ 1,086,000

21,000 1,062,000 ₱ 1,086,000

The Accumulated Depreciation account contained no entries for the year 2008. The balance on January 1, 2008 per your audit, was follows: Machine 1 Machine 2 Machine 3 Machine 4 Total

₱

84,375 39,375 33,750 22,500 ₱ 180,000

Based on your further inquiry and verification, you noted the following: 1. Machine 5 was purchased for cash; it replaced Machine 1, which was sold on this date for 3,000. 2. Machine 2 was destroyed by the thickness of engine oil used leading to explosion on December 1, 2008. Insurance of ₱ 21,000 was recovered. Machine 7 was to replace Machine 2. 3. Machine 3 was traded in for Machine 6 at an allowance of ₱ 12,000; the difference was paid in cash and charged to Production Machine account. 4. Depreciation rate is recognized at 25% per annum.

REQUIRED: Determine the adjusted balance of the Production Machine as of December 31, 2008 and Depreciation Expense for the year 2008.

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Add (Deduct) Adjustments:

a.

Understatement in crediting machinery upon sale of old machine (1): Cost of old machine Amount credited

90,000 3,000 (87,000)

b. Understatement in crediting machinery (2) destroyed: Cost of old machine Amount credited

c.

90,000 21,000 (69,000)

Understatement in recording new machine (6): Cash price of new machine Amount debited

108,000 96,000 12,000

d. Understatement in crediting machinery (3) traded-in: Cost of old machine

Unadjusted balance

(90,000)

PRODUCTION MACHINES 1,086,000 87,000 (a) 69,000 (b) (c) 12,000 90,000 (d)

852,000

Adjusted Balance

Depreciation expense for the year:

Machine 1 Machine 2 Machine 3 Machine 4 Machine 5 Machine 6 Machine 7 Machine 8

Depreciation E xpense for 2008

(90,000 x 25%) x 8/12 (90,000 x 25%) x 11/12 (90,000 x 25%) x 9/12 (90,000 x 25%) 49,500 x 8/12 (108,000 x 25%) x 3/12 (216,000 x 25%) x 1/12 (216,000 x 25%) x 1/12

15,000 20,625 16,875 22,500 16,500 6,750 4,500 4,500 ₱ 107,250

NOTES (3)

(2) (2) (2) (2)

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NOTES

1. PAS 16, paragraph 67: The carrying amount of an item of property, plant and equipment shall be derecognised: (a) on disposal; or (b) when no future economic benefits are expected from its use or disposal. This explains the adjustments done for a, b, and d. 2. PAS 16, paragraph 55: Depreciation of an asset begins when it is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. 3. PAS 16, paragraph 55 states that depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. Therefore, even if the asset was sold during the year, depreciation for the period must be recorded but only up to the date of sale.

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PROBLEM NO. 10 Theory Questions

You obtain the following information pertaining to Red Co.’s property, plant and equipment for 2008 in connection with your audit of the company’s financial statements. Audited balances at December 31, 2007:

Land Buildings Accumulated depreciation – buildings Machinery and Equipment Accumulated depreciation – machinery and equipment Delivery Equipment Accumulated Depreciation – Delivery equipment

Debit P 3,750,000 30,000,000

Credit

P6,577,500 22,500,000 6,250,000 2,875,000 2,115,000

Depreciation Data:

Buildings Machinery and Equipment Delivery Equipment Leasehold Improvements

Depreciation Method 150% declining-balance Straight line Sum of the years digits Straight line

Useful life 25 years 10 years 4 years -

Transaction during 2008 and other information are as follows: a.

On January 2, 2008, Red purchased a new truck for P500,000 cash and traded in a 2 year old truck with a cost of P450,000 and a book value of P135,000. The new truck has a cash price of P600,000; the market value of the old truck is not known.

b. On April 1, 2008, a machine purchased for P575,000 on April 1, 2003 was destroyed by fire. Red recovered P387,500 from its insurance company. c.

On May 1, 2008, cost of P4,200,000 were incurred to improve the leased office premises. The leasehold improvements have a useful life of 8 years. The related lease terminates on December 31, 2014.

d. On July 1, 2008, machinery and equipment were purchased at a total invoice cost of P7,000,000; additional cost of P125,000 for freight and P625,000 for installation were incurred. e.

Red determined that the delivery equipment comprising the P2,875,000 balance at January 1, 2008, would have been depreciated at a total amount of P450,000 for the year ended December 31, 2008.

The salvage value of the depreciable assets are immaterial. The policy of the Red Co. is to compute depreciation to the nearest month.

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REQUIRED: Based on the above and the result of your audit, answer the following: 1. How much is the Accumulated Depreciation – Buildings as of December 31, 2008? a. ₱ 7,777,500 b. ₱ 7,982,850 c. ₱ 8,377,500 d. ₱ 7,103,700 2. How much is the Accumulated Depreciation – Machinery and Equipment as of December 31, 2008? a. ₱ 8,844,375 b. ₱ 8,614,375 c. ₱ 8,830,000 d. ₱ 8,556,875 3. How much is the Accumulated Depreciation – Delivery Equipment as of December 31, 2008? a. ₱ 2,715,000 b. ₱ 2,400,000 c. ₱ 2,490,000 d. ₱ P2,805,000 4. How much is the Accumulated Depreciation – Leasehold Improvements as of December 31, 2008? a. ₱ 420,000 b. ₱ 525,000 c. ₱ 350,000 d. ₱ 630,000 5. How much is the net gain (loss) from disposal of assets for the year ended December 31, 2008? a. ₱ 100,000 b. ₱ (P35,000) c. ₱ 65,000 d. ₱ (P65,000) Solutions:

1. Accumulated Depreciation - Building NOTES

Balance: January 1, 2008 Add: Depreciation for 2008

6,577,500 1,405,350

Balance, December 31, 2008

7,982,850

Book value, January 1, 2008 (30,000,000 – 6,577,500) 150% Declining Balance (





x 150%)

Depreciation for 2008

(1)

23,422,500

6% 1,405,350

2. Accumulated Depreciation – Machinery and Equipment Balance, January 1, 2008 6,250,000 Depreciation for 2008 2,594,375 Machine destroyed by fire (575,000/10 x 5) (287,500)

Balance, December 31, 2008 Machinery and Equipment, January 1, 2008 Less: Machine destroyed by fire Balance Depreciation rate Machine destroyed by fire (575,000 x 10% x 3/12) Machine purchased, July 1 (7,750,000 x 10% 6/12) Depreciation for 2008

8,556,875 22,500,000 575,000 21,925,000 10%

(1)

2,192,500 14,375 387,500 2,594,375

Page 31 of 45



3. Accumulated Depreciation – Delivery Equipment Balance, January 1, 2008 Depreciation for 2008 Truck traded in (450,000 cost – 135,000 book value)

Balance, December 31, 2008



(315,000)

2,400,000

Delivery Equipment, January 1, 2008 Less: Depreciation on truck traded in, January 1, 2008 (450,000 x

2,115,000 600,000

*)



(1)

450,000 90,000

360,000

Depreciation on truck purchased January 2, 2008 (600,000 x



)



240,000

Depreciation for 2008 600,000 4. Accumulated Depreciation – Leasehold Improvements Cost of leasehold improvements 4,200,000 Depreciation period, May 1, 2008 – December 31, 2008 ÷ 80 months Depreciation per month 52,500 Depreciation, May 1, 2008 – December 31, 2008 (52,500 x 8 months) 420,000

5. Loss on Trade In of Truck on January 2, 2008 Trade in Value (600,000 – 500,000) Book Value

Loss on Tr ade I n

(1)

100,000 135,000

(35,000)

(2)

NOTES

1. PAS 16: Each part of an item of PPE with a cost that is significant in relation to the total cost of an item shall be depreciated separately. The depreciation method used by the entity shall reflect the pattern in which the future economic benefits of the asset are expected to be consumed. 2. PAS 16: Any gain or loss from the derecognition of an item of property, plant and equipment shall be included in profit or loss when the item is derecognized.

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PROBLEM NO. 11 Theory Questions

1. An audit has identified numerous debits to accumulated depreciation of equipment. Which of the following is most likely? a. The estimated remaining useful lives of equipment were increased. b. Plant assets were retired during the year. c. The prior year’s depreciation expense was erroneously understated. d. Overhead allocations were revised at year-end. ANSWER: B IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors: An accounting estimate means an approximation of the amount of an item in the absence of a precise means of measurement. Example is the provisions to allocate the cost of fixed assets over their estimated useful lives.

2. In testing for unrecorded retirements of equipment, an auditor might, a. Select items of equipment from the accounting records and then attempt to locate them during the plant tour. b. Compare depreciation expense with the prior year’s depreciation expense. c. Trace equipment items observed during the plant tour to the equipment subsidiary ledger. d. Scan general journal for unusual equipment retirements. ANSWER: A PSA 500 (Redrafted): “The auditor shall design and perform audit procedures that are appropriate in 1 the circumstances for the purpose of obtaining sufficient appropriate audit evidence. When designing and performing audit procedures, the auditor shall consider the relevance and reliability of the 2 information to be used as audit evidence.” Inspection of tangible assets consists of physical examination of the assets.

3. A plant manager would be most likely to provide information on which of the following? a. Adequacy of the provision for uncollectible accounts. b. Appropriateness of physical inventory valuation techniques. c. Existence of the obsolete inventory. d. Deferral certain purchases of office supplies. ANSWER: C PSA 500: “Observation consists of looking at a process or procedure being performed by the others. It includes observation of the counting of inventories by the entity’s personnel and observation of the performance of control activities”

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4. Which of the following would be least likely to address control over the initiation and execution of the equipment transactions? a. Request for major repairs are approved by a higher level than the department initiating the request. b. Pre-numbered purchase orders are used for equipment and periodically accounted for. c. Requests for purchases of equipment are reviewed for consideration for soliciting competitive bids. d. Procedures exist to restrict access to equipment. ANSWER: D PSA 315 (redrafted): Identifying and assessing the risks of material misstatement through understanding the entity and its environment.

5. When there are numerous property and equipment transactions during the year, an auditor who plans to assess control risk at a low level usually performs: a. Test of controls and extensive tests of property and equipment balances at the end of the year. b. Analytical procedures for current year property and equipment transactions. c. Test of controls and limited tests of current year property and equipment transactions. d. Analytical procedures for property and equipment balances at the end of the year. ANSWER: C PSA 330: In order to reduce audit risk to an acceptable low level, the auditor should determine overall responses to assessed risks at the financial statement level, and should design and perform further audit procedures (test of controls and substantive tests) to assessed risks at the assertion level. The auditor should perform tests of controls to obtain sufficient appropriate audit evidence that the controls were operating effectively at relevant times during the period under audit

6. Which of the following is not a control that should be established for purchases of equipment? a. Establishing a budget for capital acquisitions. b. Requiring that the department in need of the equipment order the equipment. c. Requiring that the receiving department receive the equipment. d. Establishing an accounting policy regarding the minimum peso amount of purchase that will be considered for capitalization. Answer: B Control activities are the policies and procedures that help ensure that management directives are carried out, in purchasing equipment, it is not advisable that the one to purchase is the department in need. This action will give opportunity to conduct fraud.

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7. Which of the following is not one of the auditors’ objectives in auditing depreciation? a. Establishing the reasonableness of the client’s replacement policy. b. Establishing that the methods used are appropriate. c. Establishing that the methods are consistently applied. d. Establishing the reasonableness of depreciation computations. Answer: A The auditor should test/check the calculations of depreciation and the total depreciation arrived at should be compared with that of the preceding years to identify reasons of variation. [c&d] The auditor should review the depreciation method applied to the asset at least at the end of each financial year to confirm that the depreciation charge reflects the usage. [b]

8. Which of the following is the best evidence of continuous ownership of property? a. Examination of the deed. b. Examination of rent receipts from lessees of the property. c. Examination of the title policy. d. Examination of cancelled check in payment for the property. Answer: B If the property is leased out for rent, check rent receipts to know who gets the benefits and risks from the property.

9. Which of the following best describes the auditors’ typical observation of plant and equipment? a. The auditors observe a physical inventory of plant and equipment, annually. b. The auditors observe all additions to plant and equipment made during the year. c. The auditors observe all major plant and equipment items in the clients’ accoun ts each year. d. The auditors observe major additions to plant and equipment made during the year. Answer: D Because of the limited resources and time an auditor has. So the auditor can’t test all the transactions of the company. The auditor should focus his audit on things that are material to the company.

10. Which of the following is used to obtain evidence that the client’s equipment accounts are not understated? a. Analysing repairs and maintenance expense accounts. b. Vouching purchases of plant and equipment. c. Recomputing depreciation expense. d. Analysing the miscellaneous revenue account. Answer: A One of the potential misstatement in PPE on account of frauds and errors is expenditures for repairs and maintenance recorded as PPE or vice versa.

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11. Which of the following is not a test primarily used to test property, plant and equipment accounts for overstatement? a. Investigation of reductions in insurance coverage. b. Review of property tax bills. c. Examination of retirement work orders prepared during the year. d. Vouching retirements of plant and equipment. Answer: D Testing for overstatement of property, plant and equipment will include vouching/identifying assets that are currently in use and owned by the business. Vouching retirement of plant asset will not ordinarily help in testing overstatement of property plant and equipment

12. A continuing audit client’s property, plant and equipment and accounts receivable accounts have approximately the same year-end balance. In this circumstance, when compared to property, plant and equipment one would normally expect the audit of accounts receivable to require: a. More audit time. b. Less audit time. c. Approximately the same amount of audit time. d. Similar confirmation procedures. Answer: A The audit of property, plant and equipment (PPE) would probably require less time than audit of current assets (accounts receivable) because: 1. Transactions in property, plant and equipment are usually of substantial amount, and relatively few transactions may account for it. 2. There is often little change in the PPE account from year to year. 3. Errors in year-end cutoff of plants assets transaction do not usually affect net income, as do cutoff errors in inventory.

13. When performing an audit of the property, plant and equipment accounts, an auditor should expect which of the following to be most likely to indicate a departure from generally accepted accounting principles? a. Repairs have been capitalized to repair equipment that had broken down. b. Interest has been capitalized for self-constructed assets. c. Assets have been acquired from affiliated corporations with the related transactions recorded and described in the financial statements. d. The cost of freight-in on an acquisition has been capitalized. Answer: A Extra ordinary repairs are material replacements of parts involving large sums and normally extend the useful life. Extra ordinary repairs are capitalized. Ordinary repairs are minor replacement of parts, involving small sums. Ordinary repair are charged to expense when incurred. B. is correct because PAS 16 states that “Borrowing that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset.” D. is correct because P AS 16, paragraph 16-b: the cost of an item of PPE includes any cost directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

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14. The auditor may expect a proper debit to goodwill due to: a. Purchase of a trademark. b. Establishment of an extraordinary profitable product. c. A business combination. d. Capitalization of human resources. Answer: D PAS 38, paragraph 1 states that “If an item within the scope of this standard does not meet the definition of an intangible asset, expenditure to acquire it or generate it internally is recognized as an expense when it is incurred. However, if the item is acquired in a business combination, it forms part of the goodwill recognized at the acquisition date.

15. Which of the following is a customary audit procedure for the verification of the legal ownership of real property? a. Examination of correspondence with the corporate counsel concerning acquisition matters. b. Examination of ownership documents registered and on file at a public hall of records. c. Examination of corporate minutes and resolutions concerning the approval to acquire property, plant and equipment. d. Examination of deeds and title guaranty policies on hand. Answer: D Examination of title documents, the deed, and any other supporting documents, such as closing documents, will be helpful in verifying ownership. But these are not conclusive. An inspection of public records will determine if there are any interests in the property (e.g., mortgages, judgment liens, or claims to the title) that do not appear in the auditee’s records.

16. Which of the following best describes the independent auditors’ approach to obtaining satisfaction concerning depreciation expense in the income statement? a. Verify the mathematical accuracy of the amounts charged to income as a result of depreciation expense. b. Determine the method for computing depreciation expense and ascertain that is in accordance with generally accepted accounting principles. c. Reconcile the amount of depreciation expense to those amounts credited to accumulated depreciation accounts. d. Establish the basis for depreciable assets and verify the depreciation expense. Answer: D PSA 540, in conjunction with PAS 200, states that the auditor shall evaluate, based on the audit evidence, whether the accounting estimates in the financial statements are either reasonable in the context of the applicable financial reporting framework, or are misstated.

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17. The auditors are least likely to learn of retirements of equipment through which of the following? a. Review of the purchase returns and allowances accounts. b. Review of depreciation. c. Analysis of the debits to the accumulated depreciation account. d. Review of insurance policy riders. Answer: A Purchase returns and allowances deals with returns and allowances for purchases of merchandise and not equipment. Whereas the analysis of accumulated depreciation, review of insurance policy riders since companies would ordinarily modify insurance coverage when assets retire, and the review of the property, plant and equipment account would definitely reveal retirements.

18. Which of the following is the most important control procedure over acquisitions of property, plant, and equipment? a. Establishing a written company policy distinguishing between capital and revenue expenditures. b. Using a budget to forecast and control acquisitions and retirements. c. Analysing monthly variances between authorized expenditures and actual costs. d. Requiring acquisitions to be made by user departments. Answer: B Among the elements of strong internal control for property, plant, and equipment, a budget to forecast and control acquisitions and retirements of plant assets is considered to be the most essential because it provides historical data and estimates set by the management.

19. In the examination of property, plant and equipment, the auditor tries to determine all of the following except the: a. Extent of the control risk. b. Extent of property abandoned during the year. c. Adequacy of replacement funds d. Reasonableness of the depreciation Answer: C All three choices are encapsulated in the following standards: PSA 540 which pertains to the objective of obtaining sufficient audit evidence by reviewing the reasonableness of accounting estimates and PSA 315 which deals with the necessity for risk assessment and.

20. Property acquisitions that are misclassified as maintenance expense would most likely be detected by an internal control system that provides for: a. Investigation of variances within a formal budgeting system b. Review and approval of the monthly depreciation entry by the plant supervisor. c. Segregation of duties of employees in the accounts payable department. d. Examination by the internal auditors of vendor invoices and cancelled checks for property acquisitions. Answer: A The internal auditor, apart from stressing importance to proper classification of expenses into the correct property, plant, and equipment account, must also ensure to prevent misclassification of expenses like repair and maintenance into the capital assets account by adopting different procedures.

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21. When comparing an initial audit with a subsequent year audit for a particular client, the scope of audit procedures for which of the following accounts would be expected to decrease the most? a. Accounts receivable b. Cash c. Marketable securities d. Property, plant, and equipment Answer: D Usually, there is little change in property accounts year to year. Land, buildings, and equipment often remain unchanged for many years; hence there is little accounting activity to verify. In contrast, such current assets as accounts receivable and inventory may have a complete turnover several times a year.

22. Which of the following best describes the auditor’s approach to the audit of the ending balance of property, plant, and equipment for a continuing nonpublic client? a. Direct audit of the ending balance b. Agreement of the beginning balance to prior year’s working papers and audit of significant changes in the accounts c. Audit of changes in the accounts since inception of the company d. Audit if selected purchases and retirements for the last few years Answer: B PSA 501, A7: For non-current assets and liabilities, such as property, plant and equipment, investments and long-term debt, some audit evidence may be obtained by examining the accounting records and other information underlying the opening balances. In the first audit of a company for which other independent public accountants have previously made satisfactory audits, the auditors normally may limit their work on the beginning balances of plant and equipment to a general review of past transactions in plant assets.

23. The most likely technique for the current year audit of goodwill which was acquired three years ago by a continuing audit client: a. Confirmation b. Observation c. Recomputation d. Inquiry Answer: C PSA 540, A7: Additional examples of situations where fair value accounting estimates may be required include Certain assets or liabilities acquired in a business combination, including goodwill and intangible assets. Thus recalculation is deemed to be the most likely audit technique to be applied.

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24. For which of the following accounts is it most likely that most of the audit work can be performed in advance of the balance sheet date? a. Accounts receivable b. Cash c. Current marketable securities d. Property, plant, and equipment Answer: D The audit of plant and equipment would probably require less time than the audit of current assets because there is often little change in the property accounts from year to year and errors in year-end cutoff of plant assets transactions do not usually affect net income, as do cutoff errors in inventory.

25. For which of the following ledger accounts would the auditor be most likely to analyze the details to identify understatements of equipment acquisitions? a. Service revenue b. Sales c. Repairs and maintenance expense d. Sales salaries expense Answer: C In recording expenditures on property, plant, and equipment, the logical choice usually is between a revenue expenditure and a capital expenditure. If the outlay is judged to be a revenue expenditure (rightly or wrongly), it will probably be recorded in the Repairs and Maintenance account. If items that should be capitalized are erroneously charged to Repairs and Maintenance, the result will be an understatement of property, plant, and equipment.

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PROBLEM NO. 12 Wasting Assets

In 2001, Dagumboy Corporation acquired a silver mine in Benguet. Because the mine is located deep in the Benguet mountains, Dagumboy was able to acquire the mine for the low price of ₱ 50,000. In 2002, Dagumboy constructed a road to the silver mine costing ₱ 5,000,000. Improvements to the mine made in 2002 cost ₱ 750,000. Because of the improvements to the mine and the surrounding land, it is estimated that the mine can be sold for ₱ 600,000 when the mining activities are complete. During 2003, five buildings were constructed near the mine site to house the mineworkers and their families. The total cost of the five buildings was ₱ 1,500,000. Estimated residual value is ₱ 250,000. In 2001, geologists estimated 4 million tons of silver ore could be removed from the mine for refining. During 2004, the first year of operations, only 5,000 tons of silver ore were removed from the mine. However, in 2005, workers mined 1 million tons of silver. During the same year, geologists discovered that the mine contained 3 million tons of silver ore in addition to the original 4 million tons. Improvements of ₱ 275,000 were made to the mine early in 2005 to facilitate the removal of the additional silver. Early in 2005, an additional building was constructed at the cost of ₱ 225,000 to house the additional workers needed to excavate the added silver. This building is not expected to have any residual value.

REQUIRED: Based on the above result of your audit, determine the following: (Round off depletion and depreciation rate to two decimal places )

1. Depletion for 2004 a. ₱ 6,300 b. ₱ 7,250

c. ₱ 6,500 d. ₱ 5,550

2. Depreciation for 2004 a. ₱ 1,300,000 b. ₱ 780,750

c. ₱ 1,820,000 d. ₱ 870,750

3. Depreciation for 2005 a. ₱ 250,000 b. ₱ 180,000

c. ₱ 490,000 d. ₱ 210,000

4. Depletion for 2006 a. ₱ 1,950,000 b. ₱ 2,425,000

c. ₱ 2,150,000 d. ₱ 2,275,000

5. Depreciation for 2006 a. ₱ 525,000 b. ₱ 1,225,000

c. ₱ 625,000 d. ₱ 450,000

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Solutions: 1. Depletion for 2004

Acquisition cost Road construction Improvements to the mine Total cost Estimated residual value Depletable amount Depletion rate per unit (5,200,000/4,000,000) Units extracted during the year Rate

Depletion

50,000 5,000,000 750,000 5,800,000 (600,000) ₱ 5,200,000 1.3 per ton

NOTES (2) (3) (3)

(4)

5,000 tons X 1.3 per ton ₱

6,500

(5)

2. Depletion for 2005 NOTES

Depletable amount Depletion in 2004 Remaining depletable amount Development cost in 2005 Total depletable amount Original estimate Additional estimate Total estimate Extracted in 2004 Remaining estimate - January 1, 2005 New depletion rate per unit (5,468,500/6,995,000)

₱ 5,200,000 (6,500) 5,193,500 275,000 ₱ 5,468,500 4,000,000 3,000,000 7,000,000 (5,000) 6,995,000 0.78 per ton

Units extracted during the year Rate

1,000,000 tons X 0.78 per ton

Depletion

₱

(6)

780,000

3. Depreciation for 2005 NOTES

Cost of five buildings Residual value Additional building Depreciation during 2004 {[(1,500,000-250,000)/4,000,000] x 5,000} Depreciable cost Divided by total units estimated to be extracted [(4,000,000+3,000,000) - 5,000] Rate

1,500,000 (250,000) 275,000 (1,550) 1,523,450 6,995,000 0.21 per ton


1,000,000 tons X 0.21 per ton

Depreciation

₱

210,000

(7)

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4. Depletion for 2006 NOTES

Depletable amount Depletion in 2005 Remaining depletable amount Development cost in 2005 Total depletable amount Total estimate Extracted in 2005 Remaining estimate – January 1, 2006 New depletion rate per unit (5,788,500/5,995,000)

₱ 5,468,500 (780,000) 4,688,500 1,100,000 ₱ 5,788,500 6,995,000 1,000,000 5,995,000 0.97 per ton


2,500,000 tons X 0.97 per ton

Depletion

₱

2.425,000

(6)

(5)

5. Depreciation 2006 NOTES


2,500,000 tons X 0.21 per ton

Depreciation

₱

525,000

(7)

NOTES

1. There is no comprehensive standard that is applicable to the extractive or mining industry which explains why an entity must develop its own accounting policy for the recognition of exploration and evaluation assets. PFRS 6 permits an entity to continue to apply its previous accounting policy provided that the resulting information is relevant and reliable. In general, the cost of wasting asset can be divided into four categories, namely: Acquisition cost, Exploration cost, Development cost, and Estimated Restoration cost. 2. The acquisition cost is the initial cost/purchase price of the wasting asset. 3. The road constructed is classified as an exploration cost which is incurred in an attempt to locate the natural resources. Whereas, the improvements made to the mine form part of development costs. 4. The estimated residual value must be deducted in order to arrive at the depletable cost. 5. The actual units extracted during the year shall be multiplied by the depletion rate to arrive at the depletion for the year. 6. PAS 8 paragraph 36: Changes in accounting estimate must be handled currently and prospectively which explains why the new depletion rate is utilized in the current year. 7. PAS 16 paragraph 53: The depreciable amount of an asset is determined after deducting its residual value. In practice, the residual value of an asset is often insignificant and therefore immaterial in the calculation of the depreciable amount. 8. PAS 16, paragraph 60: The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. Since the useful life of the buildings was not stated, the depreciation for the year shall be computed using the output method of depreciation. Page 43 of 45



PROBLEM NO. 13 Cost of Wasting Asset with Estimated Restoration Cost, Depletion, Depreciation of Movable and Immovable Equipment

On January 1, 2015, Harruel Mining Corp. acquired property containing mineral resources for ₱ 120,000,000. Total costs of exploration and intangible development costs incurred was ₱ 6,000,000. Harruel is mandated by the Mining Act to restore the site after 4 years. Based on most reliable measurement, the amount of restoration cost is ₱ 10,000,000 and current market -based discount rate is 12%. On the same date, Harruel acquired movable and immovable tangible equipment. The movable tangible equipment amounted to ₱ 6,000,000 while the immovable tangible equipment costs totaled ₱ 9,000,000. Geologists estimated that the total units estimated to be extracted 12,000,000. It is estimated that 1,500,000 will be extracted each year during the useful life of the wasting asset. The movable equipment has a useful of 6 years while the immovable equipment has an estimated useful of 5 years. Actual units extracted in 2015 and 2016 were 1,600,000 and 1,700,00 respectively.

REQUIRED: Based on the above data, answer the following: (Please carry over all decimal places in the computation.)

1. How much is the initial cost of the mineral deposit? a. ₱ 132,355,181 c. ₱ 126,000,000 b. ₱ 136,000,000 d. ₱ 126,355,181 2. How much is the depletion in 2015? a. ₱ 18,133,333 b. ₱ 17,647,357

c. ₱ 16,800,000 d. ₱ 16,847,357

3. How much is the 2015 depreciation of the movable equipment? a. ₱ 1,000,000 c. ₱ 750,000 b. ₱ 800,000 d. ₱ 1,125,000 4. How much is the 2015 depreciation of the immovable equipment? a. ₱ 1,800,000 c. ₱ 1,125,000 b. ₱ 1,200,000 d. ₱ 750,000 5. How much is the interest expense in 2015? a. ₱ 762,622 c. ₱ 854,136 b. Nil d. ₱ 1,588,795

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Solution Guide: Property, Plant, and Equipment

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