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College of Accounting Education

3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Phone No.: (082) 305-0645 Local 137

Auditing Problems L. Eddie I. Aguilar, CPA, MBA

Audit of Investments
Audit Objectives of Investments

1. Ascertain the adequacy of internal control structure policies and procedures over investments.
2. Ascertain that the investments are valid in that they exist and are the property of the client (existence
and rights).
3. Ascertain that all investments owned by the client at the statement of financial position date are
included in the investment accounts (completeness).
4. Ascertain that the values at which investments are carried in the financial statements are appropriate
(valuation).
5. Ascertain that the presentation and disclosure of investments, including current and non-current
classifications and necessary disclosures, is adequate.
6. Ascertain that income from investments, including gains and loss on sales and adjustments in valuation
allowances, is appropriately reflected in the financial statements.

Internal Control for Investments

1. Formal investment policies that limit the nature of investments in securities and other financial
instruments.

2. An investment committee of the board of directors that authorizes and reviews financial investment
activities for compliance with investment policies.

3. Separation of duties between the executive authorizing purchases and sales of securities, the custodian
of the securities, and the person maintaining the records of investments.

Segregation of the functions of custody and recordkeeping is achieved by the use of an independent
safekeeping agent, such as a stockbroker, bank, or trust company. Since this agent has no direct contact
with the employee responsible for maintaining accounting records, the possibilities of concealing fraud
through falsification of the accounts are greatly reduced.

If securities are not placed in the custody of an independent agent, they should be kept in the bank safe-
deposit box under the joint control of two or more of the company’s officials. A list of securities in the
box should be maintained in the box, and the deposit or withdrawal of securities should be recorded on
this list along with the date and signatures of all persons present. The safe-deposit box rental should be
in the name of the company, not in the name of an officer having custody of securities.

4. Complete detailed records of all securities owned and the related revenue from interest and dividends.

Complete detail records are essential to satisfactory control. These records frequently consist of a
subsidiary record for each security, with such identifying data as the exact name, face amount or par
value, certificate number, number of shares, date of acquisition, name of broker, cost, terms, and any
interest or dividend payments received. The purchase and sale of investments often is entrusted to a
responsible financial executive, subject to frequent review by an investment committee of the board of
directors.

5. Registration of securities in the name of the company.

6. Periodic physical inspection of securities by an internal auditor or an official having no responsibility for
the authorization, custody, or record keeping of investments.

An internal auditor or other responsible employee should, at frequent intervals, inspect the securities on
hand, compare the serial numbers and other identifying data of the securities examined with the

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accounting records, and reconcile the subsidiary record for securities with the control account. If the
entity engages in derivative transactions, the individual should also review the terms of the derivative
instruments for compliance with investment policies and proper financial accounting and disclosure.

7. Determination of appropriate accounting for complex financial instruments by competent personnel.

Audit Working Papers for Investments and Related Revenues

1. Securities count sheet.
2. Analysis of changes in investment accounts.
3. List of securities composing end-of-year balances.
4. Schedule of income, gains and losses related to investments.

Audit Program for Investment

a. Presentation and Disclosure

a.i. Examine financial statement presentation of investments.
This includes the identification and classification of different types of investments in the
statement of financial position and recognition of realized/unrealized gain and losses in the
comprehensive income.
a.ii Inquire of management and review loan documents
This is to determine possible pledging of securities for appropriate disclosure purposes.

b. Existence or Occurrence
b.i Inspect and count securities on hand.
This test ordinarily is performed simultaneously with auditor’s count of cash and other negotiable
instruments. In performing the test
a. The custodian of the securities should be present throughout the count;
b. A receipt should be obtained from the custodian when the securities are returned, and
c. All securities should be controlled by the auditor until the count is completed.

In inspecting securities, the auditor should observe such matters as the certificate number on the
document, name of owner (which should be the client, either directly or through endorsement),
description of the security, number of shares (or face value, in case of bonds), and name of issuer.
This data should be recorded as part of the auditor’s analysis of the investment account. For
securities purchase in prior years, the data should be compared with those shown on last year’s
working papers. A lack of agreement between the certificate numbers may be indicative of
unauthorized transactions for those securities.

b.ii Obtain confirmation of securities from third-party custodian

The auditor must positively confirm securities held by outsiders for safekeeping. Confirmation
should be requested as of the date securities held by the client are counted. The confirmation
process for securities is identical with the steps required in confirming receivables; that is, the
auditor must control the mailing and receive the responses directly from the custodian.

c. Rights and Obligation

c.i Verify entries in investment account
Purchases of securities should be vouched to brokers’ advices and canceled checks. Similarly,
sales should be supported by bank or brokers’ advices. Authorization for purchases and sales should
be found in the minutes of board of director’s meetings.

For investments in stock accounted for by the equity method of accounting, it is necessary for the
auditor to obtain evidence that the client’s management can exercise significant influence over the
investee. This is done through inquiry of management and by a review of the circumstances that
support management’s conclusion. Audited financial statements of the investee generally constitute
sufficient evidential matter regarding the underlying net assets and the results of operation of the
investee.

d. Completeness
d.i Obtain or prepare an account analysis for the investment and related revenue or loss account.
This procedure allows the auditor to
a. Establish the accuracy of the individual debits and credits occurring during the year, and
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b. Prove the validity of the year-end balance in the accounts.

d.ii Performance analytical procedures

By comparing dividends, interest, and other investment income with those of prior years to
ascertain the reasonableness of the completeness of recorded investment income. Calculate the
percentage of accrued investment income to total investments and estimate total accrued income
based on current investment.

e. Valuation
e.i Investigate method of accounting for equity securities
To investigate whether such securities should be accounted for under fair value/cost or equity
method.
e.ii Determine FMV of securities on the date of the financial statements.
e.iii Verify revenue earned on investments.
e.iv Examine financial statements of investee companies.
e.v Test calculations of premium and discount amortization for accuracy.

ACCOUNTING FRAMEWORK - INVESTMENTS

“Investments are assets held by an entity for the accretion of wealth through distribution such as interest,
royalties, dividends and rentals, for capital appreciation or for other benefits to the investing entity such as
those obtained through trading relationships”.

Reasons for acquiring Investments:

a. For accretion of wealth or regular income through interest, dividends, royalties, and rentals.
b. For capital appreciation as in the case of investment in land and real estate held for appreciation and
direct investments in gold, diamonds, and other precious commodities.
c. For ownership control as in the case of investment in subsidiaries and associates.
d. For meeting business requirements as in the case of sinking fund, preference share redemption fund,
plant expansion fund and other noncurrent fund.
e. For protection, as in the case of interest in life insurance contract in the form of cash surrender value.

Examples of Investments

a. Trading securities
b. Investment in equity securities
c. Investment in bonds
d. Investment in associate
e. Investment in subsidiary
f. Investment property
g. Investment in fund
h. Investment in joint venture

Financial Instruments

Characteristics of Financial Instruments

a. There must be a contract
b. There are at least two parties to the contract
c. The contract shall giver rise to a financial asset of one party and financial liability or equity instrument
of another party

Financial asset is any asset that is:

1. Cash
2. A contractual right to receive cash or another asset from another enterprise (e.g., debt securities
such as bonds, loans)
3. A contractual right to exchange financial instruments with another enterprise under conditions that
are potentially favorable (e.g., derivatives)
4. An equity instrument of another enterprise (e.g., common stocks)

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Classification of Financial Assets (IFRS 9)

1. Financial assets at fair value (include both equity and debt securities)
2. Financial assets at amortized cost (debt securities only)

The categories of financial assets under PAS 39, such as loans and receivables, available-for-sale, and held-to-
maturity is not eliminated.

Financial Assets at Fair Value

1. Held for trading (trading securities). These financial assets are measured at FV through PL “by
requirement” or required by the standard.
2. Irrevocably designated on initial recognition as at FV through PL. Example is investment in bonds can
be designated as at FV through PL even if the financial assets satisfy the amortized cost
measurement. These financial assets are measured t FV through PL “by designation”
3. All other investment in quoted equity instruments. These financial assets are measure at FV through
PL “by consequence”.

Financial Assets at Amortized Cost

Criteria:
1. The business model is to hold the financial asset in order to collect contractual cash flows on
specified dates.
2. The contractual cash flows are solely for payment of principal and interest on the principal amount
outstanding.

(This topic will be discussed further in the next session).

Hierarchal Evidence of Fair Value

1. Quoted price of identify asset in an active market.
2. Quoted price of similar asset in an active market.
3. Quoted price of identify and similar asset in an inactive market.

Initial Measurement of Financial Assets (Acquisition Costs)

Financial Assets at FV through PL

- Fair value only
- Transaction costs are not included (prescriptive not standard-based)

Financial Assets at Amortized Cost

- Fair value plus transaction costs

Investment
Interest/Dividend income
Cash

Transaction costs include fees and commissions paid to agents, advisers, brokers and dealers, levies by
regulatory agencies and securities exchange, and transfer taxes and duties. It does not include debt
premiums or discounts, financial costs and internal administrative or holding costs. PIC Q&A No. 2011-04 –
Costs of Public Offering of Shares will discussed other issues on transaction costs.

If the equity securities are acquired in an exchange, the acquisition cost is determined by reference to the
following:
If the exchange has commercial substance,
Fair value of the assets given or
Fair value of the securities acquired.

If the exchange has no commercial substance,

The cost or book value of the asset given.

If two or more equity securities are acquired at a single cost or lump sum, the single cost is allocated to the
securities acquired on the basis of their fair value. If only one security has a known market value, the single

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cost is allocated to the security with known market value an amount equal to its market value and the
remainder to the other security with no known market.
Subsequent Measurement

An entity shall subsequently measure financial asset at fair value or amortized cost depending on the entity’s
business model for managing financial assets.

Business Model
- To hold investments in order to realize fair value changes.
- To hold investment in order to collect contractual cash flows.

Other Comprehensive Income (OCI)

PFRS 9 provides that an entity may make an irrevocable election to present in OCI. Subsequent changes in
fair value of an investment in equity instrument is also reported in OCI.

Reclassification
Allowed only when it changes its business model for managing the financial assets. If reclassification occurs,
the entity shall apply the reclassification prospectively from the reclassification date. No reinstatement of
previously recognized gain, losses and interests.

The reclassification date is the first day of the reporting period following the change in business model that
results in an entity reclassifying financial asset.

Not Allowed for Reclassification

a. Change in intention related to a particular financial asset. The classification of financial asset as at FV
or amortized cost is not governed by management intent but by the entity’s business model.
b. A temporary disappearance of a particular market for a financial asset.
c. A transfer of financial asset between parts of the entity with different business models.

Reclassification from FV to Amortized Cost

The fair value at the reclassification date becomes the new carrying value of the financial asset at amortized
cost. The difference between the new carrying amount of the financial asset at amortized cost and the face
value of the financial asset shall be amortized through PL over the remaining life of the financial asset using
the effective interest method.

Reclassification from Amortized Cost to FV

The fair value at the reclassification date becomes the new carrying value of the financial asset at FV. The
difference between the previous carrying amount and fair value is recognized in PL.

Impairment

Financial Assets at Fair Value – no impairment to recognize.

Financial Assets at Amortized Cost – impairment loss is measured as the difference between the carrying
value and the present value of estimated future cash flows discounted at the original effective interest date.

Dividends

Dividend is distributions of profits to holders of equity investment in proportion to their holdings of a

particular class of capital stock.

Dividends considered as income are (This is only applicable if Fair Value/Cost Method of accounting
investment is used):

1. Cash dividends – dividends in the form of cash.

2. Property dividends – dividends in the form of property or assets other than cash.
This should be recorded in the investor’s book at fair value.

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3. Shares received in lieu of cash dividends – This is in effect a property dividend. The shares received in
lieu of cash dividends are income at fair value of the shares received. In the absence of fair value of the
shares received, the income is equal to the cash dividends that would have been received.
4. Scrip dividends – dividends in the form of promissory note.
Other Dividends (not considered as income):

1. Liquidating dividends – this represent return of invested capital.

2. Stock dividends same as those held – this is in the form of the issuing company’s own stock**. This
kind of dividend increases the number of shares held by the investor but no effect in the amount of the
investment. Stock dividend of the same class is recorded only by means of a memorandum entry on the
part of the investor.
3. Stock dividends different from those held – this is still in the form of the issuing company’s own
stock but is different from the original shares. This will be recorded by apportioning between the original
shares and the stock dividends on the basis of market of each at the date of receipt.

Investment – PS
Investment – OS

PS – mv/tmv x cost of OS = Cost of PS

OS – mv
tmv

4. Cash dividends in lieu of stock dividends – the cash received is not considered as income but as
proceeds of the stock dividends assumed received and subsequently sold. This will be recorded by
debiting the Cash for the proceeds and crediting the Investment account (stock dividend) at cost. The
difference between the proceeds and the cost of the investment (stock dividend) is considered as gain or
loss on investment.

Cash
Investment
Gain on ‘sale’

FS - 10,000 shares at P100,000

Received P2,000 cash dividend in lieu of 5% share dividend

Cash 2,000
Loss on ‘sale’ 2,762
Investment 4,762
(500/10,500 x P100,000)

How to compute the cost of the investment sold?

2014 – 10,0000 – P100,000

2015 – 12,000 – P180,000

2016 – 10,000 sold – how much is the cost of investment?

Same class of stock, but acquired from different dates (assume: cost model)
a. Specific Identification
b. FIFO
c. Weighted average

NDP
Less: Carrying value (cost)
Gain or loss on sale

Fair value model – TS/FMVTPL/FMVTOCI

Net disposal proceeds

Less: Carrying value (FMV – latest FS)
Gain or loss on sale
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**Shares of another company declared as dividends are not stock dividends but property dividends.

Other Non-Revenue Distribution from Investee

1. Stock Split is a way of restructuring the investee’s capital by affecting a change in the number of
shares of stock without capitalizing retained earnings or changing the amount of its legal capital. Stock
split does not affect the total cost of investment. But there is a decrease or an increase in the cost per
share because the total cost now will apply to a larger or smaller number of shares.
2. Stock Right is the preemptive right of the investor to acquire the new share of investee’s stock at
below the market value.

Not recorded separately Recorded Separately

(Embedded Derivatives) (Stand-Alone Derivatives)
PFRS 9 – Right is always a derivative; no
Bifurcation needed

Acquisition Memo entry Investment in SR (at fmv)

Cash

Exerrcise Investment Investment

Cash Invest. In SR
Cash

Sale of SR Cash Cash

Income/Investment Invest. In SR
Income

Expiration of SR Memo entry Loss on SR

Invest. In SR

Methods of Amortizing Bond Premium or Discount

1. Effective interest method – This method is generally accepted method in amortizing the premium or
discount for bonds other than callable and serial.
2. Accelerated method – This is applicable to callable bonds acquired at a premium. This method is
designed to bring the balance of the investment account to an amount which should not be more than
the call price on any redemption date.
3. Bond outstanding method – This method is applicable to serial bonds, whether acquired at a
premium or discount.
4. Straight line method.

THEORY
1. A company holds bearer bonds as a short-term investment. Responsibility for custody of these bonds and
submission of coupons for periodic interest collections probably should be delegated to the
a.Chief accountant.
b.Internal auditor.
c. Cashier.
d.Treasurer.

2. Of the following, which is the most efficient audit procedure for testing accrued interest earned on bond
investments?
a. Tracing interest declarations to an independent record book.
b. Recomputing interest earned.
c. Confirming interest rate with the issuer of the bonds.
d. Vouching the receipt and deposit of interest checks.

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3. During the audit of a publicly held company, the auditor could obtain written confirmation regarding
long-term bond transactions from the
a. Bond holders.
b. Client's attorney.
c. Internal auditors.
d. Trustee.

4. The auditor's program for examining long-term debt should include

a. Verification of the existence of the bondholders.
b. Examination of any bond trust agreement.
c. Inspection of the accounts payable subsidiary ledger.
d.Investigation of credits to the bond interest income account.

5. Jones was engaged to audit the financial statements of Gamma Corporation, a June 30 year-end client.
Having completed testing of the investment securities, which of the following is the best method of
verifying the accuracy of recorded dividend income?
a. Tracing recorded dividend income to cash receipts records and validated deposit slips.
b. Utilizing analytical review techniques and statistical sampling.
c. Comparing recorded dividends with amounts appearing on Federal Information Form 1099.
d. Comparing recorded dividends with a standard financial reporting service's record of dividends.

6. A company has temporarily excess funds to invest. The board of directors decided to purchase
marketable securities and assigned the future purchase and sale decisions to a responsible financial
executive. The best person(s) to make periodic reviews of the investment activity would be
a. The investment committee of the board of directors.
b. The treasurer.
c. The corporate controller.
d. The chief operating officer of the company.

7. Which of the following is a responsibility that should not be assigned to only one employee?
a. Access to securities in the company's safe deposit box.
b. Custodianship of the cash working fund.
c. Reconciliation of bank statements.
d. Custodianship of tools and small equipment.

8. When no independent stock transfer agents are employed and the corporation issues its own stocks and
maintains stock records, canceled stock certificates should
a. Be defaced to prevent reissuance and attached to their corresponding stubs.
b. Not be defaced but segregated from other stock certificates and retained in a canceled certificates
file.
c. Be destroyed to prevent fraudulent reissuance.
d. Be defaced and sent to the secretary of state.

9. Which of the following is not one of the auditor's concerns in an examination of marketable securities?
a. To determine whether securities are authentic.
b. To determine whether securities are the property of the client.
c. To determine whether securities actually exist.
d. To determine whether securities are properly classified on the balance sheet.

10. When negotiable securities are of considerable volume, planning by the auditor is necessary to guard
against
a. Unauthorized negotiation of the securities before they are counted.
b. Unrecorded sales of securities after they are counted.
c. Substitution of securities already counted for other securities which should be on hand but are not.
d.Substitution of authentic securities with counterfeit securities.

11. During its fiscal year, a company issued, at a discount, a substantial amount of first-mortgage bonds.
When performing audit work, the independent auditor
a. Confirms the existence of the bondholders.
b. Reviews the minutes for authorization.
c. Traces the net cash received from the issuance to the bonds payable account.
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d.Inspects the records maintained by the bond trustee.

12. In the audit of a medium-sized manufacturing concern, which of the following areas would be expected
to require the least amount of audit time?
a. Revenue.
b. Assets.
c. Liabilities.
d.Owner's equity.

13. All corporate capital stock transactions should ultimately be traced to the
a. Minutes of the board of directors.
b. Cash receipts journal.
c. Cash disbursements journal.
d. Numbered stock certificates.

14. If a company employs a capital stock registrar and/or a transfer agent, the registrar or agent should be
requested to confirm directly to the auditor the number of shares of each class of stock
a. Surrendered and canceled during the year.
b. Authorized at the balance sheet date.
c. Issued and outstanding at the balance sheet date.
d. Authorized, issued, and outstanding during the year.

15. The auditor's program for testing long-term debt should include steps that require
a. Verifying the existence of the bondholders.
b. Examining any bond trust indenture.
c. Inspecting the accounts payable subsidiary ledger.
d. Investigating credits to bond interest income.

16. During the year under audit, a company has completed a private placement of a substantial amount of
bonds. Which of the following steps is the most important in the auditor's tests of existence?
a. Confirm the amount issued with the bond trustee.
b. Trace cash received from the issue to the accounting records.
c. Examine bond records maintained by the transfer agent.
d. Recompute annual interest cost and the effective yield.

17. During the course of an audit, an auditor observes that the recorded interest expense seems excessive in
relation to the balance in long-term debt. This observation could lead the auditor to suspect that
a. Long-term debt is understated.
b. Discount on bonds payable is overstated.
c. Long-term debt is overstated.
d. Premium on bonds payable is understated.

18. Which of the following information is most important when auditing shareholders’ equity?
a. Changes in the capital stock account are verified by an independent stock transfer agent.
b. Stock dividends and/or stock splits during the year were approved by the shareholders.
c. Stock dividends are capitalized at par or stated value on the dividend declaration date.
d. Entries in the capital stock account can be traced to a resolution in the minutes of the board of
directors' meetings.

Problem 1
During 2016 and 2017, Salva made the following journal entries to account for transactions
involving trading securities:

2016
(a). Nov. 1 Investment in trading securities – 10% X Co. bonds 1,068,830
Cash 1,068,830
To record the purchase of P1 million bonds at 103.25
Brokerage fees were P3,000. Interest is payable
semiannually on January 1 and July 1.

CE: Investment (1m x 103.25) 1,032,500

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Interest income 33,330

Operating expenses 3,000
Cash 1,068,830

Adj:

(b). Dec. 31 Unrealized loss on trading securities 42,830

Investment in trading securities 42,830
To record the decrease in fair value of the trading
securities based on the following data.
Fair Value
Cost December 31, 2016
F. Co. stock P 252,500 P 233,500
D. Co. stock 324,500 339,500
X. Co. bonds 1,068,830 1,030,000
Total P1,645,830 P1,603,000

The unrealized loss recognized in profit or loss in 2015 was P5,000,

Were no other entries in 2016

FMV last year – 1,609,500 – 5,000 = 1,604,500

FMV this year = 1,603,000
Unrealized holding loss = 1,500

Adj: Investment 41,330

Unrealized loss – PL 41,330

Adj: Interest receivable 50,000

Interest income 50,000

2017
(c). Jan. 1 Cash 50,000
Interest income 50,000

(d). July 1 Cash 50,000

Interest income 50,000

(e). Dec. 6 Investment at FMVTOCI – F Co. 252,500

Investment in trading securities – F Co. 252,500
To reclassify F. Co. stock from trading securities to
Investment at FMVTOCI securities. Fair value was P245,000
at the date of reclassification.

Adj: Investment in TS
Invest. At FMVTOCI

(f). Dec. 31 Unrealized gain/loss on investment at FMV securities 34,830

Investment at FMVTOCI securities 3,000
Investment in trading securities 31,830
To record the decrease in fair value of investment at FMVTOCI
securities based on the following data.
Fair Value
Cost December 31, 2017
F. Co. stock P 252,500 P 249,500
D. Co. stock 324,500 326,500
X. Co. bonds 1,068,830 1,035,000
Total P1,645,830 P1,611,000

There were no other entries in 2017.

FMV this year - 1,611,000

FMV last year - 1,603,000
Unrealized holding gain 8,000

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Adj: Investment
Unrealized holding gain – PL

Adj: Interest receivable

Interest income

Based on the preceding information, determine the following:

1. Unrealized loss on trading securities for the year ended December 31, 2016
a. P42,830 b. P4,000 c. P3,500 d. P1,500

2. Unrealized gain (loss) on trading securities for the year ended December 31, 2017
a. P31,830 b. P16,000 c. P8,000 d. P(8,000)

3. Interest income on X. Co. bonds for the year ended December 31, 2016
a. P33,333 b. P16,667 c. P50,000 d. P0

4. Interest income on X. Co. bonds for the year ended December 31, 2017
a. P100,000 b. P50,000 c. P150,000 d. P66,667

5. Carrying value of investment in investment at FMVTOCI securities at December 31, 2017

a. P249,500 b. P252,500 c. P233,500 d. P0

6. An auditor testing long-term investments would ordinarily use analytical procedures to

ascertain the reasonableness of the
a. Existence of unrealized gain or losses.
b. Completeness of recorded investment income.
c. Classification as investment t FMVTOCI or trading securities.
d. Valuation of trading securities.

7. An auditor would most likely verify the interest earned on bond investments by
a. Vouching the receipt and deposit of interest checks.
b. Confirming the bond interest rate with the issuer of the bonds.
c. Recomputing the interest earned on the basis of face amount, interest rate, and period
held.
d. Testing internal controls relevant to cash receipts.

Problem 2
The following subsidiary ledger show the Investment at Fair Value Through Profit or Loss of
HART CORP. for the year 2017:
RUBIA INC.
Date Particulars Debit Credit
June 2 Purchase of 2,000 shares P570,000
10 Adjusted to market value; credit to retained
earnings 30,000
July 15 Sold 1,000 shares at P450 P450,000
Aug. 20 Received 50% share dividends (debited at
par value); credit to dividend income 150,000
Sept. 15 Stocks were split 2 for 1; credit to
investment income 450,000
Oct. 11 Sold 1,000 shares at P150 150,000

2,000 570,000
(1,000) (285,000) NDP – 450,000
1,000 + 500 285,000 CV - 285,000
X 2/1 ______ Gain – 165,000
3,000 285,000
(1,000) (95,000) NDP 150,000
2,000 190,000 CV - 95,000
Gain 55,000

ROMAGUERA INC.
Date Particulars Debit Credit
Feb. 2 Purchase 20,000 shares P3,000,000
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28 Cash dividend to share of record February

15, declared January 15 90,000
June 1 Sold 20,000 shares at P195 3,900,000
Aug. 5 Purchased 50,000 shares 7,500,000
Nov. 20 Cash received from sale of 20,000 shares
after a November 1 declaration of P15 cash
dividend per share to shareholders of
record as of December 31 3,700,000
Dec. 15 Cash dividends received 450,000

Rubia Inc. shares and Romaguera Inc. shares were selling at P150 and P190, respectively, as of
December 31, 2017.

20,000 2,910,000
(20,000) (2,910,000) NDP 3,900,000
50,000 7,500,000 CV 2,910,000
(20,000) (3,000,000) Gain 990,000
30,000 4,500,000
NDP (3,700,000 – 300,000) – 3,400,000
CV - 3,000,000
Gain - 400,000

Rubia – 2,000 x 150 = 300,000

Rom – 30,000 x 190 = 5,700,000
Total fmv = 6,000,000 vs 4,690,000 = UHG 1,310,000

Questions:
1. What is the total gain on sale of Rubia Inc. shares?
a. 165,000 b. 205,000 c. 220,000 d. 245,000

2. What is the total gain on sale of Romaguera Inc. shares?

a. 1,300,000 b. 1,600,000 c. 1,390,000 d. 1,690,000

3. What is the unrealized holding gain or loss to be reported in the Hart’s 2017 Income
Statement?
a. 0 b. 1,660,000 c. 1,210,000 d. 1,310,000

4. At what amount should Hart report its investment in its 2017 Balance Sheet?
a. 5,812,500 b. 5,850,000 c. 6,150,000 d. 6,000,000

Problem 3
You have been asked to audit the Prieto Company. During the course of your audit, you are
asked to prepare comparative data from the company’s inception to the present. You have
determined the following:

a. Prieto Company’s charter became effective on January 5, 2010, when 80,000 shares of
P10 ordinary shares and 40,000 shares of 5% cumulative, nonparticipating, preference
shares were issued. The ordinary share was sold at P12 per share and the preference share
was sold at its par value of P100 per share.

b. Prieto Company was unable to pay preference dividends at the end of its fiscal year. The
owners of the preference share agreed to accept 2 shares of ordinary shares for every 50
shares of preference shares owned in discharge of the preference dividends due on
December 31, 2010. The shares were issued on January 2, 2011. The fair market value
was P30 per share for ordinary on the date of issue.

c. Prieto Company acquired all outstanding shares of Archie Corporation on May 1, 2012, in
exchange for 40,000 shares of Prieto Company’s ordinary shares.

d. Prieto Company split its ordinary shares 3 for 2 on January 1, 2013, and 2 for 1 on
January 1, 2014.

e. Prieto Company offered to convert 20% of the preference shares to ordinary shares on
the basis of 2 shares of ordinary for 1 share of preference. The offer was accepted, and the
conversion was made on July 1, 2014.

Pre-Review Class – Applied Auditing 6th Session – Audit of Investment aguilar

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f. No cash dividends were declared on ordinary shares until December 31, 2012. Cash
dividends per share on ordinary shares were declared and paid as follows:

June 30 December 31
2002 - P 3.20
2003 P 1.50 P 2.50
2004 P 1.25 P 1.00

Questions: Based on the above and the result of your audit. Determine the following:

1. Outstanding number of ordinary shares as of December 31, 2014

a. 364,800 b. 372,800 c. 684,800 d. 380,800

2. Outstanding number of preference shares as of December 31, 2014

a. 40,000 b. 32,000 c. 24,000 d. 96,000

3. Amount of cash dividends declared and paid to shareholders for the year 2013.
a. P 486,400 b. P 729,600 c. P 304,000 d. P 990,720

4. Amount of cash dividends declared and paid to shareholders for the year 2014.
a. P 1,955,520 b. P 856,800 c. P 1,520,800 d. P 836,800

Problem 4
During the audit of the financial statements of the Abegail Company for the year ended December 31, 2016,
you determined that the company’s surplus funds have been temporarily invested in securities. The
company’s books are maintained on the accrual basis. A transcript of the investment account is presented
below:

Date Particular Debit Credit

2016
Jan. 15 Purchased 80,000 shares of A Company 1,840,000

Feb. 15 Purchased 80,000 shares of B Company 1,920,000

May 02 Received stock rights from B Company 80,000

July 02 Purchased 8,000 shares of B Company 104,000

Aug. 30 Purchased 40,000 shares of C Company 1,520,000

Dec.15 Cash received (in lieu of stock dividend)

From C Company 16,000

Dec.20 Cash dividend received from A Company __________ 72,000

TOTAL 5,464,000 88,000
Balance _________ 5,378,000
5,464,000 5,464,000

The following information and data were developed from your audit procedures:

 The B stock rights were recorded at May 2 quoted price on the stock exchange (the credit of the
journal entry was to Miscellaneous Income). The stock was quoted at P19 per share on the same day.
For 5 rights held, one share of B stock could be purchased at P13 per share. The company exercised
rights to buy 8,000 shares on July 2, when the market price was P16 per share. The rights expired on
August 15. The company accounted the right separately.

 On December 15, 2016, Abegail received cash of P16,000 in lieu of the 5% stock dividend originally
declared.

 The A Company letter accompanying its annual dividend check stated that the dividend per share of
P0.90 includes P0.10 liquidating dividend.

Pre-Review Class – Applied Auditing 6th Session – Audit of Investment aguilar

14

A Company
80,000 1,840,000
( 8,000)
1,832,000

B Company
80,000 1,920,000 – 80,000
8,000 144,000
1,984,000

If 10,000 shares were sold at P30 per share, how much is the gain or loss on sale?
Assume that 2,000 shares were from the original acquisition and the rest from
the 8,000 share acquired through the exercise of the right.

NDP - 300,000
CV - 190,000 2,000/80,000 x 1,840,000 = 46,000 + 144,000
Gain - 110,000

If the right is embedded, how much is the gain or loss?

NDP - 300,000
CV - 152,000 2,000/80,000 x 1,920,000 = 48,000 + 104,000
Gain - 148,000

C Company
40,000 1,520,000
( 72,381) 2,000/42,000 x 1,520,000
1,477,619
NDP 16,000
CV 72,381
Loss 56,381

Questions:
1. Adjusted balance of investment in A Company as of December 31, 2016:
a. 1,776,000 b. 1,832,000 c. 1,840,000 d. 1,848,000

2. Cost to be allocated on the stock rights received from B Company on May 2, 2016:
a. P80,000 b. P96,000 c. P101,053 d. P114,059

3. Correct cost of the 8,000 shares purchased on July 2, 2016:

a. P144,000 b. P154,527 c. P161,030 d. P200,000

4. Adjusted balance of investment in B Company as of Dec. 31, 2016:

a. P1,984,000 b. P1,976,000 c. P1,966,971 d. P2,024,000

5. Adjusted balance of investment in C Company as of Dec. 31, 2016:

a. P1,444,000 b. P1,447,619 c. P1,504,000 d. P1,520,000

Problem 5
The Joven Company started investing its excess cash during 2016 and the entries relating
thereto were recorded under the following investment account. You were able to obtain the
following ledger details in connection with your audit.

Particulars Date Ref. DR CR Balance

Investment in PLANAS
Co. – 500 shares 2 – 14 CV P120,000 P120,000
Investment in JAY PEE
Co. – 600 shares 2 – 20 CV 150,000 270,000
Cash dividend –
Pre-Review Class – Applied Auditing 6th Session – Audit of Investment aguilar
15

PLANAS Co. 2 – 28 CR 10,000 260,000

Sale of JAY PEE Co –
200 shares 3 – 01 CR 45,000 215,000
Receipt of PLANAS
stock dividend –
offsetting Credit to
retained earnings 4 – 30 JV 11,000 226,000
Sale of PLANAS Stocks
– 400 shares 9 – 15 CR 98,000 128,000
Sale of PLANAS Stocks
– 100 shares 10 – 12 CR 23,000 105,000
Cash Dividend PLANAS 10 - 25 CR 4,500 100,500
Co.

From the Philippine Stock Exchange the PLANAS dividends were analyzed as follows:

Dates
Kind Declared Record Payment Rent
Cash 01 – 15 02 - 15 02 - 28 P20/share
Stock 04 – 01 04 – 20 04 – 30 10%
Cash 09 – 01 09 – 30 10 – 10 P30/share

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

1. Gain or loss on sale of 200 JAY PEE shares on March 1, 2016

a. P45,000 gain b. P25,000 loss c. P5,000 loss d.
P5,000 gain

2. Gain on sale of 400 PLANAS shares on September 15, 2016

a. P6,000 b. P2,000 c. P18,000 d. P0

3. Gain or loss on sale of 100 PLANAS shares on October 12, 2016

a. P1,000 gain b. P1,000 loss c. P3,000 loss d. P3,000 gain

4. Dividend income for the year 2016

a. P16,500 b. P26,500 c. P37,500 d. P0

5. Adjusted balance of the investment account

a. P120,000 b. P110,000 c. P100,000 d. P121,000

Problem 6
Your audit of the Uy Corporation disclosed that the company owned the following securities on
December 31, 2018:

Trading Securities Cost Market

Anthony, Inc. 9,600 shares P 144,000 P184,000
Belanger, Inc. 16,000 shares 432,000 288,000
10%, P200,000 face value,
Alejandra, Inc., bonds (interest
payable Jan. 1 and July 1) 158,400 163,440

Investment at FVTOCI Cost Market

Rañeses, Inc. 32,000 shares 1,376,000 1,440,000
Antonette, Inc. 240,000 shares 6,240,000 5,840,000
Elcana, Inc. 80,000 shares 960,000 1,280,000

Amortized Cost Cost Carrying Value

12%, P2,000,000 face value,
Lester Ryan Company bonds
(interest payable annually
every December 31) 1,900,000 1,926,000

During 2019, the following transactions occurred:

Pre-Review Class – Applied Auditing 6th Session – Audit of Investment aguilar

16

Jan. 1 Received interest on the Alejandra, Inc., bonds.

Mar 1 Sold 8,000 shares of Belanger, Inc., shares for P152,000.

May 15 Sold 3,200 shares of Elcana, Inc. ,for P15 per share.

July 1 Received interest of the Alejandra, Inc., bonds.

Dec 31 Received interest on the Lester Ryan Company bonds.

31 Transferred the Lester Ryan Company bonds to the investment at FVTOCI

portfolio. The bonds were selling at 101 on this date. The bonds were purchased
on January 2, 2018. The discount was amortized using the effective interest
method.

The market values of the shares and bonds on December 31, 2019, are as follows:
Anthony, Inc. P 22 per share
Belanger, Inc. P 15 per share
Alejandra, Inc., bonds P 151,200
Rañeses, Inc. P 42 per share
Antonette, Inc. P 28 per share
Elcana, Inc. P 18 per share

Questions:
1. Gain or loss on sale of 8,000 Belanger, Inc., shares on March 1, 2019 is:
a. P 8,000 loss b. P 8,000 gain c. P 64,000 loss d. P 64,000 gain

2. Realized gain or loss on sale of 3,200 Elcana, Inc., shares on May 15, 2019 is:
a. P 9,600 loss b. P 9,600 gain c. P 3,200 loss d. P 3,200 gain

3. Total interest income for the year 2019 is:

a. P 289,640 b. 286,000 c. 260,000 d. P 251,120

4. The amount that should be reported as unrealized gain in the statement of changes in
equity regarding the transfer of Lester Ryan Company bonds to investment at FVTOCI?
a. P 123,640 b. P 94,000 c. P 64,360 d. P 0

5. Carrying value of trading securities and investment at FVTOCI securities as of December

31, 2019 should be
Trading Securities Investment at FVTOCI
a. P 602,400 P 11,441,600
b. P 602,400 P 9,446,400
c. P 482,400 P 11,524,000
d. P 482,400 P 11,466,400

Problem 7
You were able to gather the following in connection with your audit of Solano, Inc. On December
31, 2014, Solano reported the following investment at FVTOCI:

Cost Market
Sepe Corp., 40,000 shares of common stock
(a 1% interest) P1,000,000 P 880,000
Sicada Corp., 80,000 shares of common stock
(a 2% interest) 1,280,000 1,200,000
Serenio Corp., 200,000 shares of common stock
(a 10% interest) 5,600,000 5,400,000
Total P7,880,000 P7,480,000

Additional information:

 On April 1, 2015, Sepe issued 10% stock dividend when the market price of its stock was
P24 per share.

 On September 15, 2015, Sepe paid cash dividend of P0.75 per share.

Pre-Review Class – Applied Auditing 6th Session – Audit of Investment aguilar

17

 On August 30, 2015, Sicada issued to all shareholders, stock rights on the basis of one right
per share. Market prices at date of issue were P13.50 per share of stock and P1.50 per right.
Solano sold all rights on December 1, 2015 for net proceeds of P150,400.

 On July 1, 2015, Solano paid P12,160,000 for 400,000 additional shares of Serenio Corp.’s
common stock which represented a 20% investment in Serenio. The fair value of all
Serenio”s identifiable assets net of liabilities was equal to their carrying amount of
P50,800,000. As a result of this transaction, Solano owns 30% of Serenio and can exercise
significant influence over Serenio’s operating and financial policies.

 Solano’s initial 10% interest of P200,000 shares of Serenio’s common stock was acquired on
January 2, 2014 for P5,600,000. At that date, the net assets of Serenio totaled P46,400,000
and the fair value of Serenio’s identifiable assets net liabilities were equal to their carrying
amount.

 Market prices per share of the securities which are all listed in the Philippine Stock Exchange
are as follows:
12/31/2014 12/31/2015
Sepe Corp. – common P22 P23
Sicada Corp. – common 15 14
Serenio Corp. – common 27 31

 Serenio reported net income and paid dividends of:

Dividend
Net income per share
Year ended December 31, 2014 P2,800,000 None
Six months ended June 30, 2015 1,600,000 None
Six months ended December 31, 2015
(dividend was paid on 10/1/2015) 2,960,000 P1.30

 There were no other intercompany transactions between Solano and Serenio.

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

1. Net unrealized gain (loss) on investment at FVTOCI securities as of December 31, 2015
a. P20,000 loss b. P380,000 gain c. P148,000 loss d. P220,000 loss

2. Net investment income from Serenio Corp. for year ended December 31, 2015
a. P950,000 b. P1,048,000 c. P900,000 d. P1,220,000

3. Carrying amount of investment in Serenio Corp. as of December 31, 2015

a. P18,698,000 b. P18,708,000 c. P18,162,000 d. P18,308,000

4. Gain on sale of stock rights on December 1, 2015

a. P30,400 b. P8,200 c. P22,400 d. P 0

5. Which of the following audit procedure is most appropriate to determine whether recoded
investments represent investments actually owned at the balance sheet date?
a. Obtain positive confirmations as of balance sheet date of investments held by
independent custodians.
b. Trace investment transactions to minutes of the board of directors meetings to determine
that transactions were properly authorized.
c. Verify that transfers from the current to the Noncurrent investment portfolio have been
properly recorded.
d. Determine that any impairments in the price of investments have been properly
recorded.

Pre-Review Class – Applied Auditing 6th Session – Audit of Investment aguilar