AUDIT PROGRAM FOR ACCOUNTS PAYABLES

Audit Objectives:

To determine:
1. Accounts payable represent amounts currently payable to trade creditor for purchase of goods and
services as at the end of the reporting period.
2. Accounts payable have been properly recorded
3. Accounts payable are properly described and classified and adequate disclosure have been made

AUDIT PROCEDURES:

1. Obtain a list of accounts payable from the subsidiary ledger, and:

 Check its footing.
 Check if the list reconciles with the general ledger control account.
 Trace individual balances to the subsidiary ledger.
 Test accuracy of balances in the subsidiary ledger.
 Adjust non-trade accounts erroneously included in suppliers’ accounts.
 Investigate and reclassify significant debit balances.
2. Confirm accuracy of individual balances appearing in the subsidiary ledger by requesting
statements of accounts from suppliers, and:
 Reconcile suppliers’ statement of accounts with client records and investigate any
discrepancy.
 If suppliers do not respond with the requests, perform extended procedures, like:
 Reviewing payments after year-end.
 Checking supporting documents.
 Discussing the account with appropriate officer.
3. Review correspondence with suppliers for possible adjustments.
4. Test propriety of cutoff:
 Examine purchases recorded and suppliers’ deliveries made a week before and after the
end of the reporting period and ascertain whether the purchases were recorded in the
proper period.
 Investigate large amounts of purchases returned shortly after the end of the reporting
period.
5. Ascertain whether some payables are secured with asset pledges.
6. Compare payments after the reporting date with year-end schedule of accounts payable.
7. Review propriety of financial statement presentation and adequacy of disclosures.
8. Perform analytical review procedures.
9. Obtain accounts payable representation letter.
AUDIT PROGRAM FOR NONCURRENT LIABILITIES

Audit Objectives:

To determine:

1. Authorization of liabilities incurred.

2. Validity of recorded liabilities.
3. Recognition and recording of significant liabilities.
4. Compliance with terms, restrictions, conditions, and other requirements of debt agreements.
5. Assets pledged or mortgaged and other guarantees related to noncurrent liabilities are
identified.
6. Accuracy of interest and other charges related to noncurrent liabilities.
7. Proprietary of financial statements presentation and adequacy of disclosures.

Audit Procedures:

1. Obtain schedule/s of noncurrent liabilities, indicating:

As to general nature:
 Description or nature of the noncurrent liabilities.
 Creditor/s
 Original principal amount
 Interest rate
 Collateral and/or guarantees
 Terms, restrictions, conditions, and requirements imposed by the creditors
As to principal amount outstanding:
 Beginning-of-the-year balance
 Additions during the year
 Repayments or renewals during the year
 Balance-at-year-end
As to interest:
 Accrued or prepaid at the beginning of the year
 Amount incurred during the year
 Payments during the year
 Accrued or prepaid at year-end
2. Foot and cross-foot the schedule.
3. Verify accuracy of the schedule.
As to general nature:
 Obtain copies or excerpts of debt instruments and trace date to the schedule.
As to principal amount outstanding:
 Trace beginning balances to last year’s working papers, or in an initial audit, establish
accuracy of beginning balances by:
 Reference to debt instruments and prior year’s recordings
 Tracing to beginning ledger balances
  Trace proceeds to cash receipts records for new liabilities incurred in the current year.
 Trace payments to cash disbursements records and canceled checks.
 Vouch to supporting documents the renewals in the current year.
 Agree working paper ending balances with the general ledger accounts.
As to interest:
 Trace beginning balances to last year’s working papers, or in an initial audit:
 Establish accuracy by an independent computation based on debt instruments.
 Trace to beginning ledger balances.
 Recompute the interest:
 Incurred
 Accrued
 Prepaid
 Trace payments to cash records and cancelled checks.
4. Verify authorizations by reference to minutes of the board of directors’ meeting.
5. Confirm directly with the creditors or trustees the following:
 Principal amount still outstanding
 Interest rates
 Interest accrued
 Collateral and/or guarantees
6. Determine client’s compliance with loan agreements.
7. Account for the used and unused debt instruments like bond certificates and promissory notes.
8. Ascertain proper cancelation of paid or retired debt instruments.
9. Recompute the accuracy of any discount or premium amortization.
10. Reconcile interest payments with recorded liabilities.
11. Verify propriety of financial statement presentation and adequacy of disclosures.

CURRENT LIABILITIES

Under Paragraph 54 of PAS 1, as a minimum, the face of the statement of financial position shall include
the following items for current liabilities:

1. Trade and other payables

2. Current provisions
3. Short-term borrowing
4. Current portion of long-term debt
5. Current tax liability

The term “trade and other payables” is a line item for accounts payable, notes payable, accrued interest
on note payable, dividend payable and accrued expenses.

No objection can be raised if the trade accounts and notes payable are separately presented.

NONCURRENT LIABILITIES

The term “noncurrent liabilities” is a residual definition.

All liabilities not classified as current are classified as noncurrent liabilities. Noncurrent liabilities include:

a. Noncurrent portion of long-term debt

b. Finance lease liability
c. Deferred tax liability
d. Long-term obligation to officers
e. Long-term deferred revenue

ACCOUNTS PAYABLE
Illustration – Gross method

1. Purchases on account, P200,000, 2/10, n/30.

Purchases 200,000
Accounts payable 200,000

2. Assume payment is made within the discount period.

Accounts payable 200,000

Cash 196,000
Purchase discount 4,000

3. Assume payment is made beyond the discount period.

Accounts payable 200,000

Cash 200,000

Illustration – Net method

1. Purchases on account, P200,000, 2/10, n/30.

Purchases 196,000
Accounts payable 196,000

2. Assume payment is made within the discount period.

Accounts payable 196,000

Cash 196,000

3. Assume payment is made beyond the discount period.

Accounts payable 196,000

Purchase discount lost (other expense) 4,000
Cash 200,000

4. Assume it is the end of accounting period, no payment is made and the discount period has
expired.

Purchase discount lose 4,000

Accounts payable 4,000

PREMIUMS
Premiums are articles of value such as toys, dishes, silverware and other goods given to customers as
result of past sales or sales promotion activities.

Illustration:
An entity manufactures a certain product and sells it at P300 per unit.
A soup bowl is offered to customers on the return of 5 wrappers plus a remittance of P10.
The bowl costs P50, and it is estimated that 60% of the wrappers will be redeemed.
The data for the first year concerning the premium plan are summarized below.

Sales, 10,000 units at P300 each 3,000,000

Soup bowls purchased, 2,000 units at P50 100,000
Wrappers redeemed 4,000

The entries that would be made in the first year to record the sales, premiums purchase and
redemption, and year-end adjustments are:

1. To record the sales:

Cash 3,000,000
Sales 3,000,000

2. To record the purchase of the premiums:

Premiums – soup bowls 100,000
Cash 100,000

3. To record the redemption of 4,000 wrappers:

Cash (800 x 40) 8,000
Premium expense (800 x 40) 32,000
Premiums – soup bowls (800 x 50) 40,000

4. To record the liability for the premiums at the end of the first year:
Premium expense 16,000
Estimated premium liability 16,000

Computation:
Wrappers to be redeemed (60% x 10,000 wrappers) 6,000
Less: Wrappers redeemed 4,000
Balance 2,000

Premiums to be distributed (2,000/5) 400

Estimated liability (400 x 40) 16,000

Financial Statement Classification

At the end of the year, the accounts related to the premium plan are classified as follows:

Current asset:

Premiums - soup bowls 60,000

Current liability:

Estimated premium liability 16,000

Distribution cost

Premium expense 48,000

ACCOUNTING FOR WARRANTY

There are two approaches in recording the warranty expense, namely:

a. Accrual approach
b. Expense as incurred as approach

Accrual approach
The accrual approach has the soundest theoretical support because it properly matches cost with
revenue.

Illustration:

An entity sells 1,000 units of television sets at P9,000 for cash. Each television set is under warranty for
one year.

The entity has estimated from past experience that warranty cost will probably average P500 per unit
and that only 60% of the units sold will be returned for repair.

The entity incurs P180,000 for repair during the year.

Journal entries

1. To record the sales:

Cash 9,000,000
Sales 9,000,000

2. To set up the estimated liability on the warranty:

Warranty expense 300,000

Estimated warranty liability 300,000

Estimated sets to be returned (60% x 1,000) 600 sets

Multiply by estimated warranty cost per set 500
Estimated warranty liability 300,000
3. To record the payment of the actual cost:

Estimated warranty liability 180,000

Cash 180,000

The statement of financial position at the end of the year would report estimated warranty liability of
P120,000 as a current liability.

The income statement for the year would show warranty expense of P300,000.

Expense as incurred approach

The “expense as incurred approach” is the approach of expensing warranty cost only when incurred.

Another Illustration:

An entity sells refrigerators that carry a 2-year warranty against defects. The sales and warranty repairs
are made evenly throughout the year.

Based on the past experience, the entity projects an estimated warranty cost as a percentage of sales as
follows:

First year of warranty 4%

Second year of warranty 10%

2019 2020

Sales 5,000,000 6,000,000

Actual warranty repairs 140,000 300,000

Journal entries

2019

1. To record the sales:

Cash 5,000,000
Sales 5,000,000

2. To record the warranty expense:

Warranty expense 700,000

Estimated warranty liability 700,000
(14% x 5,000,000)

Note that the total warranty expense each year is 14% to be incurred over a 2-year warranty period.

3. To record the actual warranty repairs:

 Estimated warranty liability 140,000
Cash 140,000

2020

1. To record the sales:

Cash 6,000,000
Sales 6,000,000

2. To record the warranty expense:

Warranty expense 840,000

Estimated warranty liability 840,000

3.To record the actual warranty repairs:

Estimated warranty liability 300,000

Cash 300,000

At this point, on December 31, 2020, the estimated warranty liability is P1,100,000.
Warranty expense:
2019 700,000
2020 840,000 1,540,000

Actual warranty repairs:

2019 140,000
2020 300,000 440,000
Estimated warranty liability – December 31, 2020 1,100,000

BONDS PAYABLE ISSUED WITH SHARE WARRANTS

Share warrants are granted to enable the holders to acquire equity shares at a specified price during a
definite period of time.

Allocation of issue price

The bonds are assigned an amount equal to the market value of the bonds ex-warrants, regardless of
the market value of the warrants.
The residual amount or remainder of the issue price shall then be allocated to the warrants.

Illustration
An entity issued 5,000 10-year bonds, face amount P1,000 per bond, at 105. Each bond is accompanied
by one warrant that permit the bondholder to purchase 20 equity shares, par P50, at P55 per share, or a
total of 100,000 shares, 5,000 x 20.

The market value of the bond ex-warrant at the time of issuance is 98.

1. To record the issuance of the bonds

Cash (5,000,000 X 105) 5,250,000.00
Discount on bonds payable 100,000.00
Bonds payable 5,000,000.00
Share warrants outstanding 350,000.00

Issue price of bonds with warrants 5,250,000.00

Market value of bonds ex-warrants
(5,000,000 X 98) 4,900,000.00
Residual amount allocated to warrants 350,000.00

2. To record the exercise of 60% of the warrants:

Cash (60,000 X 55) 3,300,000.00
Share warrants outstanding
(60% X 350,000) 210,000.00
Share capital (60,000 X 50) 3,000,000
Share premium 510,000

3. To record the expiration of the remaining warrants

Share warrants outstanding 140,000
Share premium - unexercised warrants 140,000

Market value of bonds ex-warrants unknown

Using the preceding illustration, assume the interest is payable annually at a nominal rate of 10% per
annum.

When the bonds are issued, the prevailing market rate of interest for similar bonds without warrants is
12% per annum.

The present value of 1 at 12% for 10 periods is 0.322 and the present value of an ordinary annuity of 1 at
12% for 10 periods is 5.65.

The present value of the bond’s payable is computed as follows:

Present value of principal (5,000,000 X 0.322) 1,610,000
Present value of interest payments
(10% X 5,000,000 = 500,000 X 5.65) 2,825,000
Total present value 4,435,000

Issue price of bonds with warrants 5,250,000.00

Present value of bonds payable 4,435,000.00
Residual amount allocated to warrants 815,000.00

Journal entry to record the issuance of bonds

Cash (5,000,000 X 105) 5,250,000.00
Discount on bonds payable 100,000.00
Bonds payable 5,000,000.00
Share warrants outstanding 815,000.00

CONVERTIBLE BONDS
Convertible bonds are those which give the holders the right to convert their bond holdings into share
capital or other securities of the issuing entity within a specified period of time.

Payment of convertible bond before maturity

On December 31, 2019, the entity showed the following balances:

Bonds payable – 8% convertible, due December 31, 2024 5,000,000

Premium on bonds payable 300,000
Share capital 8,000,000
Share premium – issuance 1,000,000
Share premium – conversion privilege 600,000

The interest is payable annually every December 31. The convertible bonds are note converted but fully
paid on December 31, 2019.

On December 31, 2019, the quoted price of the convertible bonds with conversion privilege is 108 which
is the payment to the bondholder plus interest.

However, the quoted price of the bonds without the conversion privilege is 103.
 Fair value of bonds with conversion privilege
(5,000,000 X 108) 5,400,000.00
Fair value of bonds without conversion privilege
(5,000,000 X 103) 5,150,000.00
Fair value of equity component 250,000.00

Bonds payable 5,000,000.00

Premium on bonds payable 300,000.00
Carrying amount of bonds payable 5,300,000.00
Payment equal to the fair value of bods without
conversion privilege 5,150,000.00
Gain on extinquishment 150,000.00

Note that the total payment of 5,400,000 to the bondholders is partly liability of 5,150,000 and party
equity of 250,000

Journal entries

1. To record the payment before maturity

Bonds payable 5,000,000.00
Premium on bonds payable 300,000.00
Share premium - conversion privilege 250,000.00
Cash 5,400,000.00
Gain on extinguishment 150,000.00

2. To close the remaining balance of the share premium from conversion privilege
Share premium - conversion privilege 350,000.00
Share premium - issuance 350,000.00

BOND RETIREMENT PRIOR TO MATURITY DATE

When bonds are reacquired prior to maturity date, they may be canceled and permanently retired, or
held in the treasury for the future reissue when the need for fund arises.

The retirement of bonds prior to maturity date may present some complex accounting problems.

If the reacquired bonds are canceled and permanently retired, the following procedures are followed.

1. The bond premium or bond discount should be amortized up to the date of retirement.

2. The balance of the bond premium of bond discount should be determined. This balance is important
because the amount related to the bonds retired is canceled.

3. The accrued interest to date of retirement should be determined.

4. The total cash payment should be computed. This is equal to the retirement price plus the accrued
interest. The retirement price is a certain percent of the face amount of the bonds.

5. The carrying amount of the bonds retired is determined. The face amount of the bonds plus the
unamortized premium or minus the unamortized discounts gives the carrying amount of the bonds.

6. The gain or loss on the retirement of the bonds is computed.

This is the difference between the retirement price and the carrying amount of the bonds.

If the retirement price is more than the carrying amount of the bonds, there is a loss.

If the retirement price is less than the carrying amount of the bonds, there is a gain.

7. The retirement of the bonds is then recorded by canceling the bond liability together with the
unamortized premium or discount. Any accrued interest is debited to interest or expense.

Illustration
On March 1, 2019, bonds with face amount of P5,000,000 are issued for P4,730,000.

The bonds are dated March 1, 2019 and mature in 5 years, and pay 12% interest semiannually on March
1 and September 1.

The straight-line method of amortization is used for simplicity.

All of the bonds are retired on July 1, 2022 at 97%.

1. The amortization of the bond discount is recorded up to July 1, 2022. If the entity uses the calendar
period presumably, the last amortization was on December 31, 2021.

Thus, an amortization of the discount for 6 months from January 1 to July 1, 2022 should be recorded.
Interest expense 27,000.00
Discount on bonds payable 27,000.00
(270,000/5 years = 54,000 annual amortization)
(54,000 X 1/2 = 27,000)

2. Balance of the discount on bonds payable

Discount on bonds payable - March 1, 2019 270,000
Less: Amortization from March 1, 2019
to July 1, 2022 or 40 months (40/60 X 270,000) 180,000
Balance, July 1, 2022 90,000

3. The accrued interest on the date of retirement July 1, 2022 is computed as P5,000,000 X 12% X 4/12 =
200,000.
The last interest payment of interest was March 1, 2022. Thus, the accrued interest is for 4 months,
from March 1 to July 1, 2022.

4. Total cash payment

Retirement price (5,000,000 X 97) 4,850,000
Add: Accrued interest 200,000
Total cash payment 5,050,000

5. Carrying amount of the bonds payable

Bonds payable 5,000,000
Discount on bonds payable -90,000
Carrying mount on July 1, 2022 4,910,000

6. Gain on the early retirement or extinguishment

Carrying mount of bonds payable 4,910,000
Less: Retirement price 4,850,000
Gain on early retirement 60,000

7. To record the retirement of the bonds on July 1, 2022

Bonds payable 5,000,000
Interest expense 200,000
Cash 5,050,000
Discount on bonds payable 90,000
Gain on early retirement bonds 60,000

DEFERRED TAX LIABILITY

Deferred tax liability is the amount of income tax payable in future periods with respect to a taxable
temporary difference.

A deferred tax liability arises from the following:

a. When the accounting income is higher than the taxable income because of timing differences.

b. When the carrying amount of an asset is higher than the tax base.

c. When the carrying amount of the liability is lower than the tax base.

Illustration
In 2019, an entity reported in accounting income a gross profit on installment sale of 1,000,000 but not
in taxable income.
This temporary difference is expected to be reported in taxable income equally in 2020 ad 2021. The
income tax rate is 30%.
 2019 2020 2021
Accouting income 4,000,000 5,000,000 7,000,000
Taxable income 3,000,000 5,500,000 7,500,000

Since the temporary difference results to a higher accounting income in 2019, there is a deferred tax
liability.

Journal entries in 2019

1. To record the current tax expense
Income tax expense 900,000
Income tax payable (30% X 3,000,000) 900,000

2. To record the deferred tax liability

Income tax expense (30% X 1,000,000) 300,000
Deferred tax liability 300,000

The income tax payable is classified as a current liability.

The deferred tax liability is classified as noncurrent liability.