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RODRIGUEZ, Neslie Kaye A. BSA 20110811 Assignment: AUDITING 7-3.

(a) Lapping is a defalcation in which a cash shortage is concealed by delaying the crediting of cash receipts to the proper accounts receivable. The first step in the fraud is to withhold from a bank deposit cash remitted by a customer. A few days later, because the customer must receive credit for his remittance, the first customers account is credited with an amount from a remittance made by a second customer. The process requires the continuous shifting of shortages from account to account and the crediting of subsequent receipts to the wrong account receivable. (b) The following audit procedures would be used to uncover lapping: (1) Compare the detail of mailroom control listings (if prepared) to entries in the cash receipts journal, postings to the accounts receivable subsidiary ledger, and the detail of authenticated duplicate deposit slips. This procedure should indicate any delay in journalizing, posting, and/or depositing incoming cash receipts. (2) If control listings are not prepared, compare the remittance advices received with customers checks to the cash journal entries, postings to accounts receivable, and deposit slips. If the client stamps remittance advices with the date received, particular attention should be given to comparing this date with the date of the related journal entry and posting. (3) Confirm accounts receivable and give close attention to exceptions made by customers about payment dates. The confirmation procedure is better applied as a surprise at an interim date so that a person engaged in lapping will not have been able to bring the lapped accounts up to date. If the confirmations are always prepared at year-end, the confirmation procedure may be anticipated by the person doing the lapping and the shortage given a different form such as kiting of checks. (Confirmation of accounts receivables has not been discussed in this chapter, but some students may be familiar enough with this procedure to include it in their answer.)


Evolution Building Supply Outstanding Checks : Less Checks not cleared Total Disbursements Total Accountable for: BANK Recorded Missing As of Dec 31 P 41, 516 ( 7, 200) 34, 316 100, 880 (80, 880) 20, 000 Jan 1 -14 62, 964 ( 16, 400 ) 46, 564

80, 880


Form Company Requirement (a) Form Company Bank Reconciliation Statement 6.30.06 Balance per bank statement Add: Cash on hand P 27,000 9,228

Total Less: Outstanding checks Check no. 192 193 194 195 Balance as adjusted Balance per books Add: Note collected by bank Total Less: Shortage Balance as adjusted

36,228 P 1,040 720 816 692

3,268 P 32,960 P 34,700 500 35,200 2,240 P 32,960


Tarlac Company (1) Tarlac Company Proof of Cash For the month ended 12.31.06
Balance 11.30.06 Balance per bank statement Add (Deduct) Reconciling items Outstanding checks November 30 December 31 NSF checks returned in December Deposits in transit November 30 December 31 Bank charges November December Check of another company erroneously charged by bank in November, corrected in December Balance per books P 45,240 (10,000) December Receipts P100,000 Disbursements P135,240 (10,000) 4,000 (245) 2,500 20 (2,500) 3,500 20 (25) Balance 12.31.06 P10,000

(4,000) 245 3,500 25

260 P 38,020

(260) P100,740 P 128,990 P 9,770


Cordial Company Bank Reconciliation, 12.31.06 Bank Unadjusted balance Add (Deduct) Adjustments Deposit in transit (P175,250 - P50,000) Post dated customers check recorded on 12.31.06 Note collected by bank Outstanding checks (P246,750 - P14,750 - P37,210) P350,000 125,250 (1) ( 50,000) 15,000 (194,790) (2) Books P293,500

Check payable to a supplier released on Jan. 5, 2007 Check dated Jan. 4, 2007 recorded and released in Dec., 2006 Erroneous bank credit corrected on Jan. 2, 2007 As corrected Unlocated difference (shortage) Balance as adjusted

14,750 37,210 (30,000) 250,460 310,460 (60,000)

(6) (6)

(4) (3)

P250,46 0



Makati Company For all of the exceptions, the auditor is concerned about four principal things. (a) Whether there is a client error. Many times the confirmation response differences are due to timing differences for deposits in the mail and inventory in transit to the customer. Sometimes customers misunderstand the confirmation or the information requested. The auditor must distinguish between those and client errors. (b) The amount of the client error if any. (c) The cause of the error. It would be intentional, a misunderstanding of the proper way to record a transaction, or a breakdown of internal control. (d) Potential errors in the sample not tested. The auditor must estimate the error in the untested population, based on the results of the tests of the sample. Suggested steps to clear each of the comments satisfactorily are: 1. (a) Examine supporting documents, including the sales invoices and applicable sales and shipping orders, for propriety and valuation of the sales. (b) Review the cash receipts books for the period after December 31, 2005, and note any collections from the PDQ Company. The degree of internal control over cash receipts should be an important consideration in determining the reliance that can be placed on the cash receipts entries. In addition, as there is no assurance that collections after December 31 represent the payment of invoices supporting the December 31 trial balance, consideration should be given to requesting a confirmation from the PDQ Company of the invoices paid by their checks. (a) The cause should be investigated thoroughly. If the credit was posted to the wrong account, it may indicate merely a clerical error. On the other hand, posting to the wrong account may indicate lapping. (b) Such a comment may also indicate a delay in posting and depositing of receipts. If upon investigation such is the case, the company should be informed immediately so that it can take corrective steps.


3. This is a confirmation of the balance with an additional comment. Since the customer has given us the data, it is preferable to check to see that the information agrees with the companys records. Such a procedure may disclose misposting or delay in recording receipts. 4. This incomplete comment should raise an immediate question: does the customer mean paid before or paid after December 31? Because the customers intent is unknown, this account should be reconfirmed and the customer asked to state the exact date. Upon receipt

of the second confirmation, the information thereon should be traced to the cash receipts book.
5. The auditor should first evaluate how long it takes to ship goods to the customer in question. If it ordinarily takes more than five days, there is no indication of error.

A comment of this type may indicate that the company may be recording sales before an actual sale has taken place. The auditor should examine the invoice and review with the appropriate officials the companys policies. Sales, cost of sales, inventories and accounts receivable may have to be adjusted if title has not passed to the buyer as of December 31, 2005. 6. (a) Determine if such advance payment has been received and that it has been properly recorded. A review should be made of other advance payments to ascertain that charges against such advances have been properly handled.
(b) If the advance payment was to cover these invoices, the auditor should propose a reclassification of the P1,350, debiting the advance payment account and crediting accounts receivable--trade.


(a) Examine the shipping order for indications that the goods were shipped and, if available, carriers invoice and/or bill of lading for receipt of the goods.
(b) If it appears that goods were shipped, send all available information to the customer and ask the customer to reconfirm. If the customer still insists that goods were never received, all data should be presented to an appropriate company official for a complete explanation. This may indicate that accounting for shipments is inadequate and consideration should be given to reviewing the procedures to determine if improvements can be made. (c) If the goods were not shipped, the auditor should recommend an adjustment reducing sales, cost of sales, and accounts receivable, and increasing inventories.


This should be discussed with the appropriate officials and correspondence with the customer should be reviewed to allow determination whether an adjustment should be made in the amount receivable or if an allowance for doubtful accounts should be set up. As title on any goods shipped on consignment does not pass until those goods are sold, the sales entry should be reversed, inventory charged, and cost of sales credited if it is actually a consignment sale. Other so-called sales should be reviewed and company officials queried to determine if other sales actual represent consignment shipments; if so, the adjustment set forth in the preceding sentence should be made for all consignment shipments.


10. This is a noncurrent asset and should be reclassified to either deposit or prepaid rent. A review of other accounts, especially those with round numbers, may disclose other accounts that should be so reclassified. 11. This may indicate a misposting of the credit or a delay in posting the credit. Comments under 2 above would also apply to credits.


Ken Company Requirement (a)

Ken Company Accounts Receivable Aging Schedule May 31, 2006 Proportion of Total Amount in Category Probability of Non-Collection Estimated Uncollectible Amount

Age Category

Not yet due Less than 30 days past due 30 to 60 days past due 61 to 120 days past due 121 to 180 days past due Over 180 days past due

.680 .150 .080 .050 .025 .015 1.000

P 816,000 180,000 96,000 60,000 30,000 18,000 P1,200,000

.010 .035 .050 .090 .400 .900

P 8,160 6,300 4,800 5,400 12,000 16,200 P52,860

Requirement (b) Ken Company Analysis of Allowance for Doubtful Accounts May 31, 2006 June 1, 2005 balance Bad debt expense accrual (3,000,000 x .04) Balance before write-offs of bad accounts Write-offs of bad accounts Balance before year-end adjustment Estimated uncollectible amount Additional allowance needed Debit Credit 11,360 11,360 P 30,250 120,000 P150,250 108,750 P 41,500 52,860 P 11,360

Bad Debts Expense Allowance for Doubtful Accounts Requirement (c)

Steps to Improve the Accounts Receivable Situation Establish more selective credit-granting policies, such as more restrictive credit requirements or more thorough credit rating investigation. Establish a more rigorous collection policy either through external collection agencies or by Kens own personal. Charge interest on overdue accounts. Insist on cash on delivery (COD) or cash on order (COO) for new customers or poorer credit risks. 1. 2.

Risks and Costs Involved This policy could result in lost sales and increased costs of credit evaluation. Ken may be all but forced to adhere to the prevailing credit-granting policies of the office equipment and supplies industry. This policy may offend current customers and thus risk future sales. Increased collection costs could result from this policy. This policy may offend current customers and thus risk future sales. This policy could result in lost sales and increased administrative costs.


Pearl Corporation 1. Estimated bad debt percentage based on year-end accounts receivable: 28.5%# Actual bad debts Credit Sales Outstanding receivables (yearend) Percentage of outstanding receivables 2003 P 3,300a P90,000 P 9,500b 0.347 2004 P 5,700c P158,000 P 19,900d 0.286 2005 P 7,800e P210,000 P 29,500f 0.264 2006 P 16,800 P459,000 P 58,900 0.285#

a b c d e

P2,500 + P500 + P300 = P3,300 0 + P90,000 - P78,000 - P2,500 = P9,500 P4,600 + P700 + P400 = P5,700 P9,500 + P158,000 - P8,500 - P134,000 - P500 - P4,600 = P19,900 Estimated. The bad debts written off in the third year following the sale have averaged about 7.8% [(P300 + P400) (P3,300 + P5,700)] of the total actual bad debts in the previous 2 years. Therefore, the bad debts on 2005 sales of P6,200 and P1,000 are about 92.2% of the total bad debts expected on 2005 sales. P19,900 + P210,000 - P200 - P14,200 - P178,800 - P300 - P700 - P6,200 = P29,500


Bad debts estimated as a percentage of year-end accounts receivable P29,500 + P235,000 - P300 - P19,500 - P400 - P1,000 - P200,000 = P43,300 P43,300 x 0.285 = P12,340.50, or approximately P12,300. Criteria for recognition of bad debts or impairment of receivables under PAS 39 should be applied.


Charry Company Requirement (a) Adjusting Journal Entries (1) Accounts Receivable Customers accounts with credit balances (P500 + P5,000) Sales Accounts Receivable (3) (4) (5) (6) (7) (8) Subscriptions Receivable Accounts Receivable Deposit on Contract Accounts Receivable Claims Receivable Accounts Receivable Advances to Employees Accounts Receivable Advances to Affiliated Company Accounts Receivable Advances to Supplier Accounts Receivable 15,000 15,000 15,000 15,000 500 500 500 500 10,000 10,000 5,000 5,000 5,500 5,500 5,000 5,000


Requirement (b) Balance Sheet Presentation 12-31-06 Current Assets Accounts Receivable - Trade Claims Receivable Advances to Employees Advances to Supplier Investments Advances to Affiliated Company Other Assets Deposit on Contract P59,500 500 500 5,000 10,000 15,000

Shareholders Equity Subscribed Share Capital (net of subscriptions receivable of P15,000) Supporting Analysis: Charry Company Accounts Receivable -Trade 12-31-06 Balance per ledger


5,500 ( 5,000) ( 15,000) ( 15,000) ( 500) ( 500) ( 10,000) ( 5,000) ( 45,500) P

Add (Deduct) Adjustments: AJE (1) To reclassify accounts with credit balances (2) To reverse entry for consignment deliveries (3) To reclassify subscriptions receivable (4) To reclassify deposit on contract (5) To reclassify balance of claims from carrier for shipping damages (6) To reclassify employees IOUs (7) To reclassify advances to affiliate (8) To reclassify advances to supplier Net adjustments Balance as adjusted

If correct entries were made for the transactions given, the Accounts Receivable account would show the following postings: Accounts Receivable Jan. 1 Balance Charge Sales Recoveries of accounts written off P 56,000 625,000 1,000 ________ P682,000 ________ P682,000 8-25. Janes Department Store Requirement 1 Age Under 30 days 30- 60 days 61-120 days 121-240 days 241-360 days Balance P193,000 114,000 73,000 41,000 25,000 Estimated Percentage Uncollectible 0.008 0.020 0.050 0.200 0.350 Estimated Amount Uncollectible P 1,544 2,280 3,650 8,200 8,750 Collections Write offs Merchandise returns Allowance for shipping damages Balance Dec. 31 P615,000 3,500 2,500 1,500 P622,500 59,500 P682,000

Over 360 days Requirement 2 a. b. c.

19,000 P465,000


11,400 P35,824

Bad Debt Expense Allowance for Doubtful Accounts Bad Debt Expense (P35,824 + P3,000) Allowance for Doubtful Accounts Bad Debt Expense (P35,824 P2,800) Allowance for Doubtful Accounts

35,824 35,824 38,824 38,824 33,024 33,024


JC Requirement (1) Inventory, as given.......................................................... Deduct (adjustments to cost): 50% markup in (a) [P250,000 (P250,000 1.5)]. 60% markup in (b) (P10,000 x 0.60)....................... Exclusion of (c)........................................................ Incorrect amount used in (e) (P2,500 P1,000)...... Add: Freight on goods in transit in (d).............................. Corrected ending inventory...................................... Requirement (2) Income Statement a. Ending inventory overstated (P250,000 P177,467)............. b. Cost of goods sold understated............................................... c. Gross margin overstated......................................................... d. Pretax income overstated........................................................ e. Income taxes overstated (P72,533 x 0.40)............................. f. Net income overstated (P72,533 P29,013).......................... Balance Sheet: Current assets, inventory overstated............................................ Current liabilities, income taxes payable overstated.................... Retained earnings overstated........................................................ Requirement (3) Retained earnings (prior period adjustment)................... Income taxes payable...................................................... Inventory.................................................................. 43,520 29,013 72,533 P72,533 72,533 72,533 72,533 29,013 43,520 72,533 29,013 43,520 P271,500 P83,333 6,000 4,000 1,500

94,833 P176,667 800 P177,467


LRT Company LRT COMPANY Computation of Value of Inventory Lost February 16, 2006 Sales P 40,000

Less: Gross profit (40%) Cost of goods sold Finished goods, February 16 Cost of goods available for sale Less: Finished goods, December 31, 2005 Cost of goods manufactured and completed Raw materials, December 31, 2005 Raw materials purchases Raw materials available for production Raw materials before flood Raw materials used Direct labor Manufacturing overhead cost Goods in process, December 31, 2005 Cost of production Less: Cost of goods completed (from above) Goods in process inventory lost in flood Total value of inventory = destroyed by flood

16,000 P 24,000 75,000 P 99,000 72,000 P 27,000 P 65,000 20,000 P 85,000 70,000 P 15,000 30,000 15,000 80,000 P 140,000 27,000 P 113,000

(P35,000 1/2)

Raw materials lost + Goods in process lost = = (P70,000 - P35,000) + P113,000 P148,000


Y Company a. Necessary adjustments to clients physical inventory: Material in Car #AR38162--received in warehouse on January 2, 2007 Materials stranded en route (Sales price P19,270/125%) Total Less unsalable inventory Total adjustment P 8,120 15,416 23,536 1,250* P22,286

b. 1.

* If freight charges have been included in the clients inventory, the amount would be P1,600 and the amount of the total adjustment would be P21,936. Journal entry 6 probably would have a credit to purchases of P1,600 in this case. Auditors worksheet adjusting entries: Purchases Accounts Payable To record goods in warehouse but not invoiced-received on RR 1060. No entry required. Title to goods had passed. Accounts receivable Sales To record goods as sold which were loaded on December 31 and not inventories-SI 968. 12,700 12,700 P 2,183 P 2,183

2. 3.


Sales 19,270 Accounts receivable To reverse out of sales material included


in both sales (SI 966) and in physical inventory (after adjustment). 5. 6. No adjustment required. Claims receivable Purchases Freight In To record claim against carrier for merchandise damaged in transit. 1,600 1,250 350


Inventory 22,286 Cost of goods sold To adjust accounts for changes in physical inventory quantities. Sales 15,773 Accounts receivable To reverse out of sales invoices #969, #970, #971. The sales book was held open too long. This merchandise was in warehouse at time of physical count and so included therein. Requirement (b)




9-20. Requirement (a) 1. Exclude Title to the goods passed to the client on January 3, 2007 or upon receipt because the term of shipment was FOB Destination. Goods held on consignment are not owned by the client. Regular stock item even if segregated but not actually delivered as of the end of the year is still part of the clients inventory. Title to the goods passed to the client on December 31, 2006 or upon shipment because the invoice showed FOB suppliers warehouse. Goods fabricated to order for a customer are considered sold as soon as completed even if not yet delivered.

2. 3.

Exclude Include