COLLEGE OF ACCOUNTANCY I.

AUDIT OF CURRENT LIABILITIES

LYCEUM OF CEBU A. Accounts and Notes Payable

_MPC_____________________GROUP 3
1. AUDIT OF LIABILITIES
LIABILITIES ARE:
 Present obligations (legal/ constructive) of a particular
entity
 Arises from a past events or transactions (obligating event)
 Settlement requires an outflow of resources (must be to
pay cash, transfer of non-cash asset and provide service)
embodying economic benefits
INITIAL MEASUREMENT
PFRS 9 par. provides 5.1.1 provides that an entity shall measure
financial liability
1. AT AMORTIZED COST- Fair value (future cash payment to settle
the obligations) minus transaction cost
2. AT PROFIT OR LOSS - Fair value
( transaction cost directly expensed)
TRANSACTION COSTS are incremental costs that are directly
attributable to the issue of the financial liability
INCLUDES
1. Fees & commissions paid to agents, advisers, brokers
and dealers
2. Levies by regulatory agencies and SEC
3. Transfer taxes and duties
EXCLUDES
1. Debt premiums or discounts
2. Financing costs
3. Internal administrative or holding costs
SUBSEQUENT MEASUREMENT
1. AT AMORTIZED COST minus principal repayment plus/minus
cumulative amortization using effective interest method of any
difference between the initial amount and the maturity amount.
2. AT FAIR VALUE THROUGH PROFIT OR LOSS
ASSERTIONS
A. Existence or Occurrence- To determine that payable
exist as of the statement of financial position date
AUDIT PROCEDURES
1. Obtain the client a listing of accounts and notes payable
as of year end and reconcile to the general ledger
2. Vouch recorded liabilities to vendors’ statements
3. Confirm recorded liabilities directly with suppliers and
creditors. Investigate differences in liabilities reported in
the confirmations with the recorded book amounts
4. Examine bank confirmations for loans
B.
Completeness- To determine that all transactions
relating to payables have been properly recorded
AUDIT PROCEDURES
1. Perform purchases cut off examination
2. Test for unrecorded liabilities
3. Perform analytical procedures
C.
Rights and Obligations- To determine that payables
represent valid and legal claims of third parties from
the client
AUDIT PROCEDURES
1. In addition to audit procedure no. 3 (existence/
occurrence), review documentation in clients’ files
2. Examine subsequent payment to creditors
D.
Valuation or Allocation- To determine that payables
are recorded at the proper amount
AUDIT PROCEDURES
1. Vouch accounts payable schedule
2. Test computation of accrued or prepaid interest
E.Presentation and Disclosure- To determine that
payables are presented and disclosed according to
PAS/PFRS
AUDIT PROCEDURES
1. Scan list of payables to determine that each major type of
obligation is properly described and classified. Determine
that contingent liabilities are properly disclosed
2. Obtain clients’ representation letter

LIABILITIES INITIAL SUBSEQUENT B. Other Current liabilities

MEASUREMENT MEASUREMENT a) Witholding taxes payable
CURRENT FACE AMOUNT b) VAT Payable
NON CURRENT c) Unclaimed salaries and wages
1. Interest FACE AMOUNT FACE AMOUNT d) Customers’ deposits
bearing PRESENT VALUE @ AMORTIZED e) Liabilities under trust receipts
2. Non-interest COST f) Accrued expenses payable
bearing g) Income tax payable

II. AUDIT OF LONG TERM LIABILITIES

EXAMPLES
CURRENT NON-CURRENT A. Existence or Occurrence- To determine that long term debts
1. Financial liabilities 1. Non-current portion exist at year end
held for trading of long term debt AUDIT PROCEDURES
2. Bank overdraft 2. Finance lease 1. Obtain analyses of long term debt accounts and
liabilities related interest, premium and discount accounts
3. Dividends payable 3. Deferred tax liabilities 2. Review debt agreements and confirm with
4. Income taxes 4. Long term obligation to payees the principal amount, maturity date, interest rate,
entity officers etc.
5. Other non-trade 5. Long term deferred 3. Inspect bonds redeemed, retired or surrendered
payables revenue during the period
6. Current portion of
noncurrent financial B. Completeness- To determine that all transactions
liabilities relating to long term debts have been properly recorded
AUDIT PROCEDURES
1. Trace authorization for issuance of debt to
credits to the long term debt account
2. Vouch borrowing and repayment transactions
and review transactions to supporting
documents occurring at year end
C. Rights and Obligations- To determine that long term ACCRUAL APPROACH- soundest theoretical support because
debt represent valid obligation of the entity the revenue was properly matched by the cost
AUDIT PROCEDURES
1. Review minutes of board of directors’ meetings DEBIT CREDIT
2. Review payments and renewals after the Time of sale Warranty expense Estimated
statement of financial position date warranty liability
Actually/Subsequently Estimated Cash
D. Valuation or Allocation- To determine that long term incurred and paid warranty liability
debt are recorded at the proper amount Difference of estimate
AUDIT PROCEDURES and actual cost
1. Recalculate interest expense and amortization of a) AC>EST. Warranty expense Estimated
premium or discounts if any COST Estimated warranty liability
2. Ascertain the amount of long term debt b) EST. warranty liability Warranty expense
maturing within one year COST>AC

E. Presentation and Disclosure- To determine that long

term debt are presented and disclosed according to EXPENSE AS INCURRED APPROACH-Popular in practice for the
PAS/PFRS purpose of recognition of income tax and frequently justified on the
AUDIT PROCEDURES basis of expediency when warranty cost is not very substantial or
1. Evaluate presentation in the FS of the long term when the warranty period is relatively short.
debt. Examine classification of obligation as either secured or
unsecured 3. ACCRUED LIABILITIES AND DEFERRED REVENUE

The entity as an employer is required under the law to withhold

2. PREMIUM AND WARRANTY LIABILITY
from the salaries of each employee the ff:
PREMIUMS are articles of value such as toys, dishes, silverwares and
a) Income tax payable by the employee
other goods and in some cases cash payments given to customers as
b) Employee contribution to the SSS
result of past sales or sales promotion activities.
c) Employee contribution for Philhealth
d) Employee contribution to the Pag-ibig fund
DEBIT CREDIT
Sales Cash Sales
Purchase of Premiums Cash
Premiums CONTRIBUTION Debit Credit
Distribution of Cash Premiums To record gross Salaries Withholding tax
premiums to Premium expense payroll payable
customers with SSS payable
remittance (Cash) Philhealth payable
Outstanding Premium expense Estimated premium Pag-ibig payable
premium at year liability Cash
end To record Payroll tax expense SSS payable
employer’s addt’l Philhealth payable
contribution Pag-ibig payable
CUSTOMER LOYALTY PROGRAM To record Withholding tax Cash
- designed to reward customers for past purchases and to remittance of the payable
provide them with incentives to build brand loyalty, retain withheld amounts SSS payable
their valuable customers and increase sales volume and the addt’l Philhealth payable
through granting award credits often described as points. contribution Pag-ibig payable
- VALUE ADDED TAX
Recognition and measurement To record the sale Cash/Accounts Sales
Receivable Output Vat
 separate component of the initial sale transaction and To record Purchase Purchases Cash/ Accounts
accounted as a future delivery of goods or services of goods from Input VAT Payable
 consideration received/allocated is measured at fair value supplier
and subsequently recognized as revenue depending on To recognize the net Output VAT Input VAT
1. the entity supplies the award itself liability every end of VAT payable
2. third party supplies the award the month
INITIAL SUBSEQUENT To record VAT payable Cash
The entity supplies the Deferred revenue Revenue subsequent
award itself payment of net
liability
Third party supplies Revenue at point of GIFT CERTIFICATES
the award initial sale PAYABLE
To record sold gift Cash Gift Certificate
a) Principal @ gross certificates payable
consideration Redemption of gift Gift Certificate Sales
b) Agent allocated to award certificates payable
credits
Expired or Gift Certificate Forfeited gift
@net amount
unredeemed gift payable certificates
retained to its own
certificates
account

WARRANTY

- providing free repair services or replacement during a

period specified if the products sold are defective wherein
at the point of sale a liability is incurred depending on the
approach used by the entity.
REFUNDABLE DEPOSITS Multiply by
- consist of cash property received from customers but Bonus
which are refundable after compliance with certain
conditions CASE 4. Income before after tax but before bonus

Illustration Bonus = Bonus rate (Income before bonus and before tax -T
A deposit of P 10,000 is required from the customer for returnable Tax = Tax rate (Income before bonus and before tax-Bonus)
containers cost P8,000 Bonus = Bonus rate(Income before bonus and before tax- Tax rate
Cash 10,000 (Income before bonus and before tax-Bonus))
Container’s deposit 10,000

Assume that the customer returns the containers B = .10 (4,400,000-T)

Container’s deposit 10,000 T = .30 (4,400,000-B)
Cash 10,000 B = .10 (4,400,000 -.30 (4,400,000-B))
Failure to return the containers B = .10 (4,400,000-1,320,000+.30B)
B = 440,000-132,000+.03B
Container’s deposit 10,000 B-.03B = 440,000-132,000
Containers 8,000 .97B = 308,000
Gain on sale of containers 2,000 B = 308,000/.97
B = 317,526

BONUS COMPUTATION

FOUR VARIATIONS
Bonus expressed as a certain percent of: PROOF
1. Income before bonus and before tax
2. Income after bonus before tax Income before bonus and before tax 4
3. Income after bonus after tax Tax (4,400,000-317,526*30%) (
4. Income before after tax but before bonus Income after tax but before bonus 3
Multiply by
Illustration Bonus
Income before bonus and before tax 4,400,000.00 4,400,000
Bonus 10%
Income tax rate 30% 30%

4. DEFERRED REVENUE/ UNEARNED REVENUE

CASE 1. Income before bonus and before tax
- Income already received but not yet earned
Income before bonus and before tax 4,400,000
Multiply 10%
Illustration
Bonus 440,000
An entity sells an equipment service contracts agreeing to service
CASE 2. Income after bonus before tax
equipment for a 2 year period. Cash receipt from the contracts is
credited to unearned service revenue and service contract costs are
Bonus = Bonus rate (Income before bonus and before tax-
charged to service contract expense.
Bonus)
Bonus = .10 (4,400.000-B) Revenue from service contracts is recognized as earned over the
= 440,000-.10B service period of the contracts. The ff. transactions are made in the
B+.10B= 440,000 first year:
B= 440,000/1.10
B=400,000 Cash receipts from service contracts 1,
Service contract costs paid
Service contract revenue recognized
CASE 3. Income after bonus after tax
Journal entries
Bonus = Bonus rate (Income before bonus and before tax -Bonus-Tax)
Tax = Tax rate (Income before bonus and before tax-Bonus) 1. To record the cash receipts from service contracts sold
Bonus = Bonus rate(Income before bonus and before tax-Bonus- Tax Cash 1,000,000
rate (Income before bonus and before tax-Bonus)) Unearned service revenue 1,000,000
2. To record the service contract costs paid
B = .10 (4,400,000-B-T) Service contract expense 500,000
T = .30 (4,400,000-B) Cash 500,000
B = .10 (4,400,000-B-.30 (4,400,000-B)) 3. To record the service contract revenue recognized
B = .10 (4,400,000-B-1,320,000+.30B)
B = 440,000-.10B-132,000+.03B Unearned service revenue 800,000
B+.10B-.03B = 440,000-132,000 Service contract revenue 800,000
1.07B = 308,000
B = 308,000/1.07
B = 287,850
T = .30 (4,400,000-287,850)
T = 1,233,645

PROOF

Income before bonus and before tax 4,400,000

Bonus ( 287,850)
Tax ( 1,233,645)
Income after bonus and after tax 2,878,505
 5. Guarantee

5. PROVISION

- uncertainty about the timing or amount of the future
expenditure
- may be the equivalent of an estimated liability or loss
contingency that is accrued because it is both probable
and measurable
ILLUSTRATION: PREMIUM
An entity manufactures a certain product and sells it at P500 per
unit. A soup bowl is offered to customers on the return of 5
wrappers plus a remittance of P10.

CONDITIONS IN RECOGNITION The bowl costs P50, and it is estimated that 80% of the wrappers will
 the entity has present obligation arising from the be redeemed.
contract, legislation or other operation of law or
when the entity has created a valid expectation that it The data for the first year concerning the premium plan are
will accept certain responsibilities as a result of past summarized below.
event
 is probable that settlement requires an outflow of Sales, 10,000 units at P500 each 5,
resources embodying economic benefits Soup bowls purchased, 4,000 units at P50 each
 amount of obligation can be measured reliably Wrappers redeemed

Probable as a rule of thumb means more than 50% likely or Required: Prepare Journal entries.
substantially more

MEASUREMENT
 BEST ESTIMATE that the entity would rationally pay to ILLUSTRATION: CUSTOMER LOYALTY PROGRAM
settle the obligation at the end of reporting period or to
transfer it to a third party at that time A. Entity supplies the awards itself
MEASAUREMENT
Individual outcome Single obilgation adjusted for An entity, a grocery retailer, operates a customer loyalty program.
other possible effect The entity grants program members loyalty points when they spend
a specified amount on groceries.
Midpoint of the range Continuous range of possible
outcomes and range is likely as
Program members can redeem the points for further groceries and
any other in each point
points have no expiry date,
All possible outcomes Large population of items
weighted During 2017, the entity granted 10,000 points. Management expects
that 80% or 8,000 of these points will be redeemed. The fair value of
ILLUSTRATION each loyalty point is estimated at P100.

An entity is a defendant in a patent infringement suit. The lawyers
believe that there is a 60% chance that the court will not dismiss the
case and the entity will incur an outflow of future economic
benefits.
If the court rules against the entity in favor of the claimant, the
lawyers believe that there is 30% chance the entity will be required
to pay the damages of P4,000,000 and a 70% chance that the
damages will be P2,000,000.
A 10% risk adjustment factor to the probabilities of the expected ash
flows is considered appropriate to reflect the uncertainties in the
cash flow estimate.
Weighted probabilities
30% x 4,000,000 x 60%
70% x 2,000,000 x 60%
Expected cash outflow
Risk adjustment factor (10% x 1,560,000)
Estimated amount of provision
The sales during 2017 amounted to P8,000,000 including the loyalty
points and 4,000 points have been redeemed during the year in
exchange for groceries.
In 2018, the management revised its expectations and now expects
that 90% or 9,000 points will be redeemed altogether and the entity
redeemed 4,100. In the same year, further 900 points are
redeemed.
Management continues to expect that only 9,000 points will be ever
redeemed and no more points will be redeemed after 2019.
Prepare Journal entries for the year 2017, 2018 and 2019.
B Third Party supplies the award.
720,000
An entity, a retailer of electrical goods, participates in a customer
840,000
loyalty program operated by an airline. The entity grants program
1,560,000
members
156,000 one air travel point of every P1,000 spent on electrical
goods.
1,716,000

Program members can redeem the points for travel with the airline
OTHER MEASUREMENT CONSIDERATAIONS subject to availability.
1. Risks and uncertainties
2. Present value of obligation The entity pays the airline P90 for each point. During the current
3. Future events year, the entity sold electrical goods for P5,000,000 and granted
4. Expected disposal of assets 5,000 points. The fair value of the point is P100.
5. Reimbursements
If the entity has collected the consideration allocated to the points,
6. Changes in provision
prepare all the necessary entries
7. Use of provision
8. Future operating losses
a) on its own account
9. Onerous contract
b) on behalf of the airline

WARRANTY: ACCRUAL APPROACH

EXAMPLES OF PROVISION
1. Warranties An entity sells 1,000 units of television sets at P9,000 each for cash.
2. Environmental contamination Each television set is under warranty for one year and the entity has
3. Decommissioning or abandonment costs estimated from past experience that warranty cost will probably
4. Court case average P500 per unit and that only 60% of the units sold will be
returned for repair. The entity incurs P180,000 for repairs during the management’s assertion of
year, a. Existence or occurrence c. Completeness
b. Presentation and disclosure d. Valuation or allocation
Required:
2. An auditor performs a test to determine whether all merchandise
1.Prepare all necessary entries. for which the client was
billed was received. The population for this test consists of all
2. Estimated warranty at the end of the year a. Merchandise received c. Canceled checks
b. Vendors’ invoices d. Receiving reports
WARRANTY: EXPENSE AS INCURRED APPROACH
3. The primary audit test to determine if accounts payable are
An entity sells refrigerators that carry a 2 year warranty against
valued properly is
defects. The sales and warranty repairs are ma de evenly throughout
a. Confirmation of accounts payable
the year.
b. Vouching accounts payable to supporting documentation
c. An analytical procedure
Based on past experience, the entity projects an estimated warranty
d. Verification that accounts payable was reported as a current
cost as a percentage of sales as follows:
liability in the balance
First year of warranty 4% sheet.

Second year of warranty 10% 4. Which of the following procedures is least likely to be performed
before the balance sheet
Sales and accrual warranty repairs for 2 years are as follows: date?
a. Observation of inventory
2016 2017 b. Testing of internal control over cash
c. Search for unrecorded liabilities
Sales 5,000,000 6,000,000 d. Confirmation of receivables

Actual warranty repairs 140,000 300,000 5. An audit assistant found a purchase order for a regular supplier in
the amount of P5,500.
Required: Prepare Journal entries for the year 2016 & 2017 The purchase order was dated after receipt of goods. The purchasing
agent had forgotten to issue purchase order. Also a disbursement of
ACCRUED LIABILITIES AND DEFERRED REVENUE P450 for materials did not have a receiving report. The assistant
ILLUST. 1 wanted to select additional purchase orders for
investigation but was unconcerned about lack of receiving report.
An entity reported the ff. payroll of the employees for the month of The audit director should
January: a. Agree with the assistant because the amount of the purchase
Gross Payroll 500,0000 order exception was considerably larger than the 500,000
receiving report
Income tax withheld (20,000) exception
SSS Contribution (4,000) b. Agree with the assistant because the cash disbursement clerk had
Pag-ibig Contribution (2,000) been assured by the receiving clerk that the failure to fill out a
Net Payroll) (1,000) report didn’t happen very often.
473,000 c. Disagree with the assistant because two problems have an equal
In relation to the month of January, the entity is required to make risk of loss associated with them.
the ff. additional contribution: d. Disagree with the assistant because the lack of a receiving report
SSS 6,000 has a greater risk of loss associated with it.
Philhealth 3,000
Pag-ibig 2,000 6. When using confirmation to provide evidence about
Total Contribution 11,000 completeness assertion for accounts
payable, the appropriate population most likely is
Journal entries a. Vendors with whom the entity has previously done business.
1. To record Gross payroll b. Amounts recorded in the accounts payable subsidiary ledger.
Salaries 500,000 c. Payees of checks drawn in the month after the year end.
Withholding tax payable 20,000 d. Invoices filed in the entity’s open invoice file.
SSS payable 4,000
Philhealth payable 2,000 7. Which of the following is a substantive test that an auditor is most
Pag-ibig payable 1,000 likely to perform to
Cash 473,000 verify the existence and valuation of recorded accounts payable?
2. To record employers addt’l Cont. a. Investigating the open purchase order file to ascertain that pre-
Payroll tax expense 11,000 numbered purchase orders are used and accounted for.
SSS payable 6,000 b. Receiving the client’s mail, unopened, for a reasonable period of
Philhealth payable 3,000 time after year end to search for unrecorded vendor’s invoices.
Pag-ibig payable 2,000 c. Vouching selected entries in the accounts payable subsidiary
3. To record the remittance of the amounts withheld and the ledger to purchase orders and receiving reports.
payment of the addt’la cont. d. Confirming accounts payable balances with known suppliers who
Withholding tax payable 20,000 have zero balances.
SSS payable 10,000 8. Only one of the following four statements, which compare
Philhealth payable 5,000 confirmation of accounts payable with suppliers and confirmation of
Pag-ibig payable 3,000 accounts receivable with debtors is false. The false statement is that
Cash 38,000 a. Confirmation of accounts receivable with debtors is a more widely
accepted auditing
procedures than is confirmation of accounts payable with suppliers.
b. Statistical sampling techniques are more widely accepted in the
confirmation of accounts payable than in the confirmation of
accounts receivable.
COMPREHENSIVE c. As compared with the confirmation of accounts receivable, the
confirmation of accounts payable will tend to emphasize accounts
1. In auditing accounts payable, an auditor’s procedures most likely with zero balances at the balance sheet date.
will focus primarily on
d. It is less likely that the confirmation request sent to the supplier
will show the amount owed than that request sent to the debtor will
show the amount due.
9. When title to merchandise in transit has passed to the audit client
the auditor engaged in
the performance of a purchase cut-off will encounter the greatest
difficulty in gaining
assurance with respect to the
a. Quantity b. Quality c. Price d. Terms
10. Which of the following audit procedures is least likely to detect
an unrecorded liability?
a. Analysis and recomputation of interest expense.
b. Analysis and recomputation of depreciation expense.
c. Mailing of standard bank confirmation forms.
d. Reading of the minutes of meetings of the board directors.
11. Unrecorded liabilities are most likely to be found during the
review of which of the
following documents?
a. Unpaid bills c. Bills of lading
b. Shipping records d. Unmatched sales invoices
12. Which of the following audit procedures is best for identifying
unrecorded trade accounts
payable?
a. Reviewing cash disbursements recorded subsequent to the
balance sheet date to determine whether the related payables apply
to the prior period.
b. Investigating payables recorded just prior to and just subsequent
to the balance sheet date to determine whether they are supported
by receiving reports.
c. Examining unusual relationships between monthly accounts
payable balances and recorded cash payments.
d. Reconciling vendors’ statement to the file of receiving reports to
identify items received just prior to the balance sheet date.
13. In verifying debits to perpetual inventory records of a
nonmanufacturing firm, the auditor
is most interested in examining the purchase
a. Journal b. Requisitions
c. Orders d. Invoices
14. Which of the following procedures relating to the examination of
accounts payable could
the auditor delegate entirely to the client’s employees?
a. Test footings in the accounts payable ledger
b. Reconcile unpaid invoices to vendors statements
c. Prepare a schedule of accounts payable
d. Mail confirmations for selected account balances
15. An auditor’s purpose in reviewing the renewal of a note payable
shortly after the balance
sheet date most likely is to obtain evidence concerning
management’s assertions about
a. Existence or occurrence c. Completeness
b. Presentation and disclosure d. Valuation or allocation.
16. An auditor’s program to audit long term debt should include
steps that require
a. Examining bond trust indentures
b. Inspecting the accounts payable subsidiary ledger.
c. Investigating credits to the bond interest income account.
d. Verifying the existence of the bondholders.
17. In an audit of bonds payable, an auditor expects the trust
indenture to include the
a. Auditee’s debt-to-equity ratio at the time of issuance.
b. Effective yield of the bonds issued.
c. Subscription list.
d. Description of the collateral
18. In auditing long-term bonds payable, an auditor most likely will
a. Perform analytical procedures on the bond premium and discount
accounts.
b. Examine documentation of assets purchased with bond proceeds
or liens
c. Compare interest with the bond payable amount for
reasonableness.
d. Confirm the existence of individual bondholders at year-end.
19. The audit procedures used to verify accrued liabilities differ from
those employed for the
verification of accounts payable because
a. Accrued liabilities usually pertain to services of a continuing
nature while accounts payable are the result of completed
transactions
b. Accrued liability balances are less material than accounts payable
balances.
c. Evidence supporting accrued liabilities in nonexistence while
evidence supporting accounts payable is readily available.
d. Accrued liabilities at year-end will become accounts payable
during the following year.
20. The auditor is most likely to verify accrued commissions payable
in conjunction with the
a. Sales cutoff test
b. Verification of contingent liabilities
c. Review of post balance sheet date disbursements
d. Examination of trade accounts payable
PROBLEMS
1. At the beg. of the current year, Mabuhay company offer the
customers a pottery cereal bowl if they send in three boxtops from
the products and P10. The entity estimated that 60% of the boxtops
would be redeemed.
During the current year, the entity sold 675,000 boxes and
customers redeemed 330,000 boxtops receiving 110,000 bowls.
The cost of each bowl is P25.
a) What is the premium expenses for the current year?
b) What is the liability for outstanding premiums at year end?
2. MAY BUKAS PA COMPANY estimated the annual warranty
expense at 2% of annual net sales. The net sales for 2017 amounted
to P4,000,000.
On January 1, 2017, the warranty liability was P60,000 and the
warranty payments during 2017 totaled P50,000.
a) What is the warranty expense for 2017?
b) What is the warranty liability on Dec. 21, 2017?
3. KAYA NATIN ITO COMPANY reported gross payroll of P600,000 for
the month of Januaary. The entity paid the payroll net of the ff.
deductions:
Income tax 7
SSS 1
Philhealth 5
Pag-IBIG 7
In addition, the entity recognized its additional contributions for the
ff. in relation to January payroll:
SSS 1
Philhealth 6
Pag-IBIG 8
What is the total payroll tax liability?