Substantive Testing for PPE

Problem 1(Asset Acquisition) Mahinhin Company purchased the following assets and
constructed a building as well. All this was done during the current year.

Assets 1 and 2
These assets were purchased as a lump sum for P104,000 cash. The following information
was gathered.
Depreciation to
Initial Cost on Date on Seller’s Book Value on
Description Seller’s Books Books Seller’s Books Appraised Value
Machinery P100,000 P50,000 P50,000 P90,000
Equipment 60,000 10,000 50,000 30,000

Asset 3
This machine was acquired by making a P10,000 down payment and issuing a P30,000, 2-
year, zerointerest- bearing note. The note is to be paid off in two P15,000 installments made at
the end of the first and second years. It was estimated that the asset could have been purchased
outright for P35,900.

Asset 4
This machinery was acquired by trading in used machinery. (The exchange lacks commercial
substance.)
Facts concerning the trade-in are as follows.
Cost of machinery traded P100,000
Accumulated depreciation to date of sale 36,000
Fair value of machinery traded 80,000
Cash received 10,000
Fair value of machinery acquired 70,000

Asset 5
Office equipment was acquired by issuing 100 shares of P8 par value common stock. The
stock had a market price of P11 per share.

Construction of Building
A building was constructed on land purchased last year at a cost of P180,000. Construction
began on February 1 and was completed on November 1. The payments to the contractor were
as follows.
Date Payment
2/1 P120,000
6/1 360,000
9/1 480,000
11/1 100,000
To finance construction of the building, a P600,000, 12% construction loan was taken out on
February 1.

The loan was repaid on November 1. The firm had P200,000 of other outstanding debt during
the year at a borrowing rate of 8%.

Requirements:
Record the acquisition of each of these assets.

Problem 1:
Magalang Corporation, a manufacturer of steel products, began operation on October 1, 2004.
The accounting department of Magalang has started the fixed-asset and depreciation presented
below.
MAGALANG CORPORATION
Fixed Asset and Depreciation Schedule
For Fiscal Years Ended September 30, 2005, and September 30, 2006

Depreciation
Expense Year
Ended Sept. 30
Acq. Dep.
Assets Date Cost Salvage Method Lif 2005 2006
e
Land 10/1/0 ? N/A N/A N/ N/A N/A
A 4 A
Bldg. 10/1/0 ? P320,00 Straight- ? P139,60 ?
A 4 0 line 0
Land 10/1/0 ? N/A N/A N/ N/A N/A
B 4 A
Bldg. Under ? Straight- 30 - ?
B Const. - line
Donat 10/2/0 ? 24,000 150% 10 ? ?
ed 4 declining
equip. balance
Mach. 10/2/0 ? 48,000 Sum-of- 8 ? ?
A 4 the-
years’-
digits
Mach. 10/1/0 ? - Straight- 20 - ?
B 5 line
N/A – Not applicable
You have been asked to assist in completing this schedule. In addition in ascertaining that the
data already on the schedule are correct, you have obtained the following information from
the Company’s records and personnel:

a. Land A and Building A were acquired from a predecessor corporation. Magalang paid
P6,560,000 for the land and building together. At the time of acquisition, the land had an
appraised value of P720,000, and the building had an appraised value of P6,480,000.

b. Land B was acquired on October 2, 2004, in exchange for 20,000 newly issued shares of
Magalang’s common stock. At the date of acquisition, the stock had a par value of P5 per
share and a fair value of P30 per share. During October 2004, Magalang paid P128,000 to
demolish an existing building on this land so it could construct new building.

c. Construction of building B on the newly acquired land began on October 1, 2005. By

September 30, 2006, Magalang has paid P2,560,000 of the estimated total construction
costs of P3,600,000. It is estimated that the building will be completed and occupied by
July 2007.

d. Certain equipment was donated to the corporation by a local university. An independent

appraisal of the equipment when donated placed the fair market value at P240,000 and the
salvage value at P24,000.

e. Machinery A’s total cost of P1,319,200 includes installation expense of P4,800 and normal
repairs and maintenance of P119,200. Salvage value is estimated at P48,000. Machinery
A was sold on February 1, 2006.

f. On October 1, 2005, Machinery B was acquired with a down payment of P45,920 and the
remaining payments to be made in 11 annual installments of P48,000 each beginning
October 1, 2005. The prevailing interest rate was 8%.

QUESTIONS:
Based on the above and the result of your audit, answer the following:

1. The cost of Building A is

a. P5,904,000 c. P656,000
b. P6,560,000 d. P 0
2. The cost of Land B is
a. P600,000 c. P228,000
b. P728,000 d. P 0
3. The cost of Machine B is
a. P370,080 c. P388,592
b. P416,000 d. P389,776

4. The total depreciation expense for the year ended September 30, 2006 is
 a. P264,296 c. P265,667
b. P415,000 d. P262,608

Problem 3
Your new audit client, Magalang Company, prepared the trial balance below as of December
31, 2006. The company started its operations on January 1, 2005. Your examination resulted
in the necessity of applying the adjusting entries indicated in the additional data below.

Magalang Company
TRIAL BALANCE
December 31, 2006
Debits Credits
Cash P510,000
Accounts receivable – net 600,000
Inventories, December 31, 2005 669,000
Land 660,000
Buildings 990,000
Accumulated depreciation, building P19,800
Machinery 444,000
Accumulated depreciation, machinery 45,000
Sinking fund assets 75,000
Bond discount 75,000
Treasury stock, common 105,000
Accounts payable 567,000
Accrued bond interest 11,250
First mortgage, 6% sinking fund bonds 679,500
Common stock 1,500,000
Premium on common stock 150,000
Stock donation 180,000
Retained earnings, December 31, 2005 222,450
Net sales 2,625,000
Purchases 850,500
Salaries and wages 507,000
Factory operating expenses 364,500
Administrative expenses 105,000
Bond interest 45,000          
P6,000,000 P6,000,000

Additional data are as follows:

(1) The 1,500,000 common stock was issued at a 10 percent premium to the owners of the
land and buildings on December 31, 2004, the date of organization. Stock with a par
value of 180,000 was donated back by the vendors. The following entry was made:
 Treasury stock P180,000
Stock donation P180,000
The stock was donated because the proceeds from its subsequent sale were to be
considered as an allowance on the purchase price of land and buildings in proportion to
their values as first recorded. The treasury stock was sold in 2006 for P75,000, which was
credited to Treasury Stock.
(2) On December 31, 2006, a machine costing P15,000 when the business started was
removed. The machine had been depreciated at 10 percent during the first year. The only
entry made was one crediting the Machinery account with its sales price of P6,000.
(3) Depreciation is to be provided on the straight-line basis, as follows: buildings, 2 percent of
cost; machinery, 10 percent of cost. Ignore salvage values.
QUESTIONS:
Based on the above and the result of your audit, you are to provide the answers to the
following:

1. The correct balance of Land account as of December 31, 2006 is

a. P660,000 c. P630,000
b. P588,000 d. P 0

2. The adjusted carrying value of Building as of December 31. 2006 is

a. P907,200 c. P905,400
b. P950,400 d. P945,000

3. The adjusted carrying value of Machinery as of December 31, 2006 is

a. P399,000 c. P354,000
b. P345,000 d. P348,000

4. The adjusted depreciation expense for 2006 is

a. P648,000 c. P63,900
b. P62,400 d. P63,000

5. How much is the gain or loss on sale of machinery on December 31, 2006?
a. P6,000 loss c. P6,000 gain
b. P7,500 loss d. P7,500 gain

Problem 4
On January 1, 2012, Mapagpala Corporation purchased for P500,000 a tract of land (site
number 101) with a building. Mapagpala paid a real estate broker’s commission of P36,000,
legal fees of P6,000, and title guarantee insurance of P18,000. The closing statement
indicated that the land value was P500,000 and the building value was P100,000. Shortly after
acquisition, the building was razed at a cost of P54,000.
Mapagpala entered into a P3,000,000 fixed-price contract with Biyaya Builders, Inc. on
March 1, 2012, for the construction of an office building on land site number 101. The
building was completed and occupied on September 30, 2013. Additional construction costs
were incurred as follows.

Plans, specifi cations, and blueprints P21,000

Architects’ fees for design and supervision 82,000

The building is estimated to have a 40-year life from date of completion and will be
depreciated using the 150% declining-balance method.

To finance construction costs, Mapagpala borrowed P3,000,000 on March 1, 2012. The loan
is payable in 10 annual installments of P300,000 plus interest at the rate of 10%. Mapagpala’s
weighted-average amounts of accumulated building construction expenditures were as
follows.

For the period March 1 to December 31, 2012 P1,300,000

For the period January 1 to September 30, 2013 1,900,000

Requirements
(a) Prepare a schedule that discloses the individual costs making up the balance in the land
account in respect of land site number 101 as of September 30, 2013.
(b) Prepare a schedule that discloses the individual costs that should be capitalized in the
office building account as of September 30, 2013. Show supporting computations in good
form.

(AICPA adapted)
Problem 5:
(Purchases by Deferred Payment, Lump-Sum, and Nonmonetary Exchanges) Klamath
Company,
a manufacturer of ballet shoes, is experiencing a period of sustained growth. In an effort to
expand its production capacity to meet the increased demand for its product, the company
recently made several acquisitions of plant and equipment. Rob Joffrey, newly hired in the
position of fixed-asset accountant, requested that Danny Nolte, Klamath’s controller, review
the following transactions.

Transaction 1
On June 1, 2012, Klamath Company purchased equipment from Wyandot Corporation.
Klamath issued a P28,000, 4-year, zero-interest-bearing note to Wyandot for the new
equipment. Klamath will pay off the note in four equal installments due at the end of each of
the next 4 years. At the date of the transaction, the prevailing market rate of interest for
obligations of this nature was 10%. Freight costs of P425 and installation costs of P500 were
incurred in completing this transaction. The appropriate factors for the time value
of money at a 10% rate of interest are given below.
Future value of P1 for 4 periods 1.46
Future value of an ordinary annuity for 4 periods 4.64
Present value of P1 for 4 periods 0.68
Present value of an ordinary annuity for 4 periods 3.17

Transaction 2
On December 1, 2012, Klamath Company purchased several assets of Yakima Shoes Inc., a
small shoe manufacturer whose owner was retiring. The purchase amounted to P220,000 and
included the assets listed below. Klamath Company engaged the services of Tennyson
Appraisal Inc., an independent appraiser, to determine the fair values of the assets which are
also presented below.

Yakima Book Value Fair Value

Inventory P 60,000 P 50,000
Land 40,000 80,000
Buildings 70,000 120,000
P170,000 P250,000

During its fiscal year ended May 31, 2013, Klamath incurred P8,000 for interest expense in
connection with the financing of these assets.

Transaction 3
On March 1, 2013, Klamath Company exchanged a number of used trucks plus cash for
vacant land adjacent to its plant site. (The exchange has commercial substance.) Klamath
intends to use the land for a parking lot.

The trucks had a combined book value of P35,000, as Klamath had recorded P20,000 of
accumulated depreciation against these assets. Klamath’s purchasing agent, who has had
previous dealings in the secondhand market, indicated that the trucks had a fair value of
P46,000 at the time of the transaction. In addition to the trucks, Klamath Company paid
P19,000 cash for the land.

Instructions
(a) Plant assets such as land, buildings, and equipment receive special accounting treatment.
Describe the major characteristics of these assets that differentiate them from other types of
assets.
(b) For each of the three transactions described above, determine the value at which Klamath
Company should record the acquired assets. Support your calculations with an explanation of
the underlying rationale.
(c) The books of Klamath Company show the following additional transactions for the fiscal
year ended May 31, 2013.
(1) Acquisition of a building for speculative purposes.
(2) Purchase of a 2-year insurance policy covering plant equipment.
(3) Purchase of the rights for the exclusive use of a process used in the manufacture of ballet
shoes. For each of these transactions, indicate whether the asset should be classified as a plant
asset. If it is a plant asset, explain why it is. If it is not a plant asset, explain why not, and
identify the proper classification.
(CMA adapted)

Problem 6
Gabaldon Company’s property, plant and equipment and accumulated depreciation balances at December
31, 2005 are:

Accumulated
Cost Depreciation

Machinery and equipment P1,380,000 P 367,500

Automobiles and trucks 210,000 114,326
Leasehold improvements 432,000 108,000
Additional information follows:
Depreciation methods and useful lives:
Machinery and equipment – straight line; 10 years.
Automobiles and trucks – 150% declining balance; 5 years, all acquired after 2001.
Leasehold improvements – straight line
Depreciation is computed to the nearest month.
Salvage values are immaterial except for automobiles and trucks which have estimated
salvage values equal to 15% of cost.
Other additional information:
a. Gabaldon entered into a 12-year operating lease starting January 1, 2003. The leasehold
improvements were completed on December 31, 2002 and the facility was occupied on
January 1, 2003.
b. On July 1, 2006, machinery and equipment were purchased at a total invoice cost of
P325,000. Installation cost of P44,000 was incurred.
c. On August 30, 2006, Gabaldon purchased new automobile for P25,000.
d. On September 30, 2006, a truck with a cost of P48,000 and a carrying amount of P30,000
on December 31, 2005 was sold for P23,500.
e. On December 20, 2006, a machine with a cost of P17,000, a carrying amount of P2,975 on
date of disposition, was sold for P4,000.
QUESTIONS:
Based on the above and the result of your audit, answer the following:
1. The gain on sale of truck on September 30 is
a. P2,680 c. P250
b. P6,500 d. P 0
2. The gain on sale of machinery on December 20, 2006 is
a. P1,025 c. P13,000
b. P2,725 d. P 0
3. The adjusted balance of the property, plant and equipment as of December 31, 2006 is
a. P1,919,000 c. P2,307,000
b. P2,388,500 d. P2,351,000
4. The total depreciation expense for the year ended December 31, 2006 is
a. P185,402 c. P138,000
b. 245,065 d. P221,402
5. The carrying amount of the property, plant and equipment as of December 31, 2006 is
a. P1,567,497 c. P1,578,547
b. P1,290,547 d. P1,617,322

Auditing Theories: Substantive Testing

Select the best answer for each of the following:

1. Which of the following questions would an auditor least likely include on an internal
control questionnaire concerning the initiation and execution of equipment transactions?
a. Are procedures in place to monitor and properly restrict access to equipment?
b. Are requests for major repairs approved at a higher level than the department initiating
the request?
c. Are prenumbered purchase orders used for equipment and periodically accounted for?
d. Are requests for purchases of equipment reviewed for consideration of soliciting
competitive bids?

2. Property acquisitions that are misclassified as maintenance expense would most likely be
detected by internal control procedures that provide for
a. Review and approval of the monthly depreciation entry by the plant supervisor.
b. Investigation of variances within a formal budgeting system.
c. Examination by the internal auditor of vendor invoices and canceled checks for
property acquisitions.
d. Segregation of duties of employees in the accounts payable department.

3. A weakness in internal accounting control over recording retirements of equipment may

cause the auditor to
a. Trace additions to the "other assets" account to search for equipment that is still on
hand but no longer being used.
b. Inspect certain items of equipment in the plant and trace those items to the accounting
records.
c. Select certain items of equipment from the accounting records and locate them in the
plant.
 d. Review the subsidiary ledger to ascertain whether depreciation was taken on each item
of equipment during the year.

4. The most significant audit step in substantiating additions to the office furniture account
balance is
a. Comparison to prior year's acquisitions.
b. Examination of vendors' invoices and receiving reports for current year's acquisitions.
c. Review of transactions near the balance sheet date for proper period cutoff.
d. Calculation of ratio of depreciation expense to gross office equipment cost.

5. An auditor is verifying the existence of newly acquired fixed assets recorded in the
accounting records. Which of the following is the best evidence to help achieve this
objective?
a. Oral evidence obtained by discussions with operating management.
b. Documentary support obtained by vouching entries to subsidiary records and invoices.
c. Documentary support obtained by reviewing titles and tax returns.
d. Physical examination of a sample of newly recorded fixed assets.

6. In auditing plant assets and accumulated depreciation for proper valuation, the auditor
should do all except the following:
a. Physically inspect major plant assets additions.
b. Recalculate depreciation expense on a test basis.
c. Vouch repairs and maintenance expense on a test basis.
d. Vouch major additions by reference to underlying documentation.

7. To verify the proper value of costs charged to real property records for improvements to
the property, the best source of evidence would be:
a. A letter signed by the real property manager asserting the propriety of costs incurred.
b. Original invoices supporting entries into the accounting records.
c. A comparison of billed amounts to contract estimates.
d. Inspection by the auditor of real property improvements.

8. To test the accuracy of the current year's depreciation charges, an auditor should rely most
heavily on
a. Comparison of depreciation schedule detail with schedules supporting the income tax
return.
b. Re-computation of depreciation for a sample of plant assets.
c. Tracing of totals from the depreciation schedule to properly approved journal entries
and ledger postings.
d. Vouching of the current year's fixed asset acquisitions.

9. The audit procedure of analyzing the repairs and maintenance accounts is primarily
designed to provide evidence in support of the audit proposition that all
a. Capital expenditures have been properly authorized.
 b. Expenditures for fixed assets have been recorded in the proper period.
c. Expenditures for fixed assets have been capitalized.
d. Non-capitalizable expenditures have been properly expensed.

10. Assets may suffer an impairment in value for a variety of reasons, but not likely as a result
of:
a. A corporate restructuring.
b. Slumping demand for uncompetitive products.
c. Significant increases in market share.
d. Obsolescence.