DEMONSTRATIVE CPA EXAMINATION

AUDITING PROBLEMS cviesca 06/16//2023

INSTRUCTIONS: Select the correct answer for each of the following questions. Mark only one
answer for each item by shading the box corresponding to the letter of your choice on the answer
sheet provided. STRICTLY NO ERASURES ALLOWED. Use pencil No. 1 only.

SOUTHWEST AIRWAYS CORPORATION

1. Prepare the audit adjustments required in the problem.

2. Post the net adjustment at the Working Balance Sheet (WBS) and Working Profit Loss
(WPL).
3. Compute the final balances of each account on your WBS and WPL, proceed to the
questionnaire and transfer all answers to the final answer sheet.
4. Some peso amounts in the problems are rounded off to the nearest thousands.
5. Assume no other issues, except those discussed in the problem.

PROBLEM:

Southwest Airways Corporation was incorporated ten years ago as a common carrier engaged in
the transportation of passengers, mail, merchandise and other freight by air. It also performs
agricultural aerial application of chemicals and also do cloud seeding operation. Its main office is
located in Pasay City and it has several branches operating in Cebu, Cagayan de Oro, Palawan
and Boracay.

You were re-appointed as auditor for the year 2019. On January 5, 2020, when you visited
Southwest office for a surprise cash count, you ere given by the controller a copy of the
unadjusted trial balance as of December 31, 2019.

Based on your review of the corporate records, you discovered that some bank accounts are not
recorded regularly. You noted the following information:

1. The transfer of funds from PCIB – Davao to PCIB – Manila amounting to P 500,000 was
not recorded.
2. Collection of current receivables from customers in Davao deposited to PCIB totaling
P 85,000 was not recorded.
 3. A check prepared of December 28, 2019 for P 15,000 payable to a pilot based in Cebu
was not released until January 5, 2020. This was booked as other assets.
4. The sales report from Cagayan de Oro for the last week of December 2019 arrived in
Manila only on January 15, 2020. Revenues from charter sales amounted to P 75,000
while those from commuter sales totaled P 48,000. These were deposited to PCIB –
Cagayan de Oro but not yet recorded as of year-end.
5. Ticket Nos. 1038 – 1042 for a commuter flight to Boracay for 5 passengers amounting to
P 23,000 which were recorded as cash sales in December were cancelled. Refund for said
tickets net of penalty charge of P 100 per ticket has not been made as of December 31,
2019. Penalty and other service charges are credited to other income.
6. Postdated checks from passengers for charter flights in January 2020 totaling P 55,000
were included in the deposits in transit and recorded as revenues in December 2019.
7. Various bank charges totaling P 3,250 were not recorded.
8. Cash on hand totaling P 12,500 representing income from cargoes shipped to Boracay on
December 30 – 31, 2019 as other income. This was included as income for January 2020.

Southwest Air furnished you an aging of accounts receivable and you noticed several
outstanding accounts for more than one year still included in the schedule but collectibility is
highly uncertain. Upon discussion with the controller, he agreed that you include these account
for write-off totaled P 97,000. It is also the policy of the company to provide allowance for
doubtful accounts as follows:

Current – 1 to 3 months – 2% over Over 6 months to 1 year – 10%

Over 3 months to 6 months – 5% Over 1 year – 15%
The breakdown of accounts receivables based on the schedule is as follows:
Current – 1 to 3 months P 4,518,000
Over 3 months to 6 months 606,000
Over 6 months to 1 year 419,000
Over 1 year 237,000
Total P 5,780,000

Southwest’s idle funds are regularly lent out to affiliate at market rates. As of December 31,
2019, total notes receivable amounted to P 1,500,000 which earns interest at 13% per annum
maturing after 90 days, value date of this note is October 2, 2019. No accrual was made as of
year-end.

The company uses the perpetual method for accounting spare parts inventory. Stock ledger cards
are maintained for each item and costing is done whenever there are movements – either receipt
or issuance of the inventory list was given to you but the total does not tally with general ledger
whose balance is over by P 128,900. Your review showed that some issuances of parts totaling
P 85,700 as evidenced by slips acknowledge by the mechanic were not recorded in the books but
reflected in the stock cards. Also, some purchases paid in cash totaling P 43,200 were not
included in the inventory list but already recorded in the books.

Engine inventory per books does not tally with the list submitted to you which is short by
P 1,700,000. You noted that 3 engines taken from the warehouse on December 1, 2019, were
installed in the aircrafts whose old engines costing P 1,300,000 have been fully depreciated and
retired but no entry was made in the books. The costs of the new engines installed in the 3
aircrafts are as follows:
Beechcraft RPC 1213 P 520,000
Twin Otter RPC 1214 700,000
Cesna RPC 1215 480,000
P 1,700,000

As a matter of policy, engines are capitalized and included in aircraft account and depreciated on
estimated total flying hours while the hull or body of the aircrafts is depreciated over 15 years
based n straight-line method. As per record the estimated flying hours and number of hours
flown for December for the three aircrafts are as follows:

Estimated No. of
Flying Hours Hours Flown

Beechcraft RPC 1213 2,000 120

Twin Otter RPC 1214 3,500 210
Cesna RPC 1215 1,800 100

Property and equipment consists of:

Aircrafts (including engine replacements) P 28,750,000
Delivery equipment 2,600,000
Furniture and equipment 1,380,000
Tools and equipment 920,000
Total P 33,650,000

Southwest Airways has a 20–year lease contract on the building it is occupying which will expire
on September 30, 2019. It provides for an annual rental of P 600,000. Payment for one year was
made on September 28, 2019 and this was reflected as prepaid rent.
The building under lease was renovated at a cost of P 780,000 which was booked as repair
expenses on October 1, 2019. Based on your discussion with the controller, these improvements
will be amortized over the remaining term of the lease.

On June 30, 2019, motor vehicle costing P 200,000 with accumulated depreciation of P 190,000
was sold for P 25,000. Cash was debited and delivery equipment was credited for the sales
proceeds.

A new aircraft was acquired on December 30, 2019 on an installment basis. The installment
price of the equipment was P 1,000,000. The terms require down payment of P 300,000 and the
balance is payable in three equal annual installments beginning in December 2020. A promissory
note was issued for the balance of P 900,000. The down payment of P 300,000 was recorded as a
debit to aircrafts and a credit to cash.

Accounts payable represents liabilities for purchases of aviation gas and oil, spare parts and
engines. As of year-end however, it included advances fro officers totaling P 1,000,000 which
were used for working capital. As per agreement, this will be paid back within one year.

You noted in your review that certain spare parts purchases on account totaling P 99,000, which
are already in the warehouse were not recorded in the books and the stock ledger cards.

Your review of subsequent events revealed some payments pertaining to December 2019 which
were not accrued at year-end. These are:

Check No. 111 P 12,570 Telephone charges

Check No. 112 28,900 Electric bills
Check No. 113 3,400 Water bills
Check No. 114 34,520 Pilot overtime
Check No. 115 2,150 Office supplies
Total P 81,540

In January 2019, the company issued P 10,000,000 of 10–year bonds at 90. The discount was
charged to interest expense in 2019. Interest on the bonds is 14% payable quarterly on January 1,
April 1, July 1 and October 1 of each year. No accrual was made as of December 31, 2019.

The company declared a 20% stock dividend on September 30, 2019 but no entry has yet been
made on the books. During the meeting of the board of directors held on December 15, 2019, a
10% cash dividend was declared to stockholders of record as of December 31, 2019, payable on
or before January 20, 2020.

It has been the policy of the company to appropriate for contingencies an amount equivalent to
5% of the annual net income after tax. No appropriation has been set up for the year 2019.

SOUTHWEST AIRWAYS CORPORATION

Working Balance Sheet
December 31, 2019

AUDIT FINAL
PER BOOKS
ADJUSTMENTS BALANCES

Current
Cash 1,396,000
Accounts receivable - trade 5,780,000
Allowance for doubtful accts. (166,000)
Notes receivable 1,500,000
Interest receivable
Inventories
Engines 6,500,000
Spare parts 7,280,000
Gas and oil 477,000
Total inventories 14,257,000
Prepayments 600,000
Total 23,367,000
Property, plant and equipment
Aircrafts 28,750,000
Delivery equipment 2,600,000
Office furniture & equipment 1,380,000
Tools and equipment 920,000
Leasehold improvements  
Total 33,650,000
Accumulated depreciation (7,280,000)
Net 26,370,000
Other assets 1,350,000
Total 51,087,000

Current Liabilities
Accounts Payable 7,058,000
Accrued expenses 249,000
Interest payable
Income tax payable 1,589,000
Dividends payable
Other liabilities 1,754,000
Total 10,650,000
Long-term liabilities
Notes payable-net of current
Portion
Discount on notes payable
Bond payable 10,000,000
Discount on bonds payable  
Total 10,000,000
Stockholders' equity
Paid-in capital 20,000,000
Retained earnings - free 9,601,000
 Appropriated for contingencies 836,000
Total 30,437,000
Total 51,087,000

SOUTHWEST AIRWAYS CORPORATION

Working Profit and Loss
Year Ended December 31, 2019

AUDIT FINAL
PER BOOKS
ADJUSTMENTS BALANCES

Revenues – charter &

commuter 42,800,000
Prime cost
Aviation gas and oil 15,170,000
Aviation insurance 4,500,000
Depreciation - aircrafts 4,250,000
Parts and accessories 2,980,000
Pilots' salaries 3,250,000
Total (30,150,000)
Gross Profit 12,650,000
Operating expenses (7,480,000)
Income from operations 5,170,000
Other income 720,000
Other charges (1,350,000)
Income before charges 4,540,000
Provision for income tax (1,589,000)
Net income 2,951,000
Retained earnings, beginning 6,650,000
Dividends declared
Appropriated contingencies  
Retained earnings, end 9,601,000

1 CASH
a. P 1,573,250 b. P 1,396,000 c. P 1,450,250 d. P 1,628,250

2 ACCOUNTS RECEIVABLE - TRADE

a. P 5,598,000 b. P 5,683,000 c. P 5,695,000 d. P 5,780,000

3 ALLOWANCE FOR DOUBTFUL ACCOUNTS

a. P 181,860 b. P 194,410 c. P 166,000 d. P 198,100

4 NOTES AND INTEREST RECEIVABLE

a. P 1,535,208 b. P 1,500,000 c. P 1,534,667 d. P 1,534,192

5 ENGINE INVENTORY
a. P 4,899,000 b. P 4,800,000 c. P 6,543,300 d. P 6,500,000

6 SPARE PARTS INVENTORY

a. P 7,280,000 b. P 7,194,000 c. P 7,293,300 d. P 7,379,000

7 PREPAYMENTS
a. P 500,000 b. P 400,000 c. P 600,000 d. P 450,000

8 TOTAL CURRENT ASSETS

a. P 21,726,357 b. P 23,244,357 c. P 21,544,357 d. P 23,367,000
9 AIRCRAFTS
a. P 29,450,000 b. P 28,750,000 c. P 29,150,000 d. P 29,850,000

10 DELIVERY EQUIPMENT
a. P 2,400,000 b. P 2,625,000 c. P 2,425,000 d. P 2,600,000

11 ACCUMULATED DEPRECIATION
a. P 5,719,400 b. P 5,909,400 c. P 7,280,000 d. P 7,209,400

12 OTHER ASSETS
a. P 1,335,000 b. P 1,300,000 c. P 1,350,000 d. P 1,365,000

13 TOTAL ASSETS
a. P 52,324,957 b. P 53,624,957 c. P 53,724,857 d. P 51,087,000

14 ACCOUNTS PAYABLE
a. P 6,157,000 b. P 7,157,000 c. P 7,058,000 d. P 6,058,000

15 ACCRUED EXPENSES
a. P 292,620 b. P 249,000 c. P 330,540 d. P 296,090

16 INCOME TAX PAYABLE

a. P 1,589,000 b. P 1,886,588 c. P 1,898,721 d. P 1,988,222

17 OTHER LIABILITIES
a. P 2,754,000 b. P 1,776,500 c. P 2,776,500 d. P 1,754,000

18 CARRYING VALUE OF SHORT AND LONG-TERM NOTES PAYABLE

a. P 600,000 b. P 400,000 c. P 700,000 d. P 900,000

19 CARRYING VALUE OF BONDS PAYABLE

a. P 10,100,000 b. P 9,100,000 c. P 10,000,000 d. P 9,000,000

20 PAID-UP CAPITAL
a. P 26,400,000 b. P 22,000,000 c. P 20,000,000 d. P 24,000,000

21 RETAINED EARNINGS - FREE

a. P 3,562,360 b. P 3,599,886 c. P 9,601,000 d. P 3,725,229

22 APPROPRIATED FOR CONTINGENCIES

a. P 1,012,310 b. P 1,010,335 c. P 836,000 d. P 174,335

23 TOTAL REVENUES
a. P 42,845,000 b. P 42,800,000 c. P 42,923,000 d. P 42,820,000

24 PRIME COST
a. P 30,270,220 b. P 30,284,420 c. P 30,150,000 d. P 30,370,120

25 OPERATING EXPENSES
a. P 7,696,520 b. P 7,809,380 c. P 7,480,000 d. P 7,029,380

26 INCOME FROM OPERATIONS

a. P 5,170,000 b. P 4,878,260 c. P 5,445,500 d. P 5,080,580

27 OTHER INCOME
a. P 782,667 b. P 720,000 c. P 733,000 d. P 748,000

28 OTHER CHARGES
a. P 1,453,250 b. P 1,803,250 c. P 1,350,000 d. P 803,250

29 NET INCOME
 a. P 3,503,662 b. P 3,486,695 c. P 2,951,000 d. P 3,526,196

30 DIVIDENDS DECLARED
a. P 2,400,000 b. P 6,400,000 c. P 2,000,000 d. P 4,000,000

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