Far Eastern University

Institute of Accounts, Banking, and Finance

Department of Accountancy
ACT1205 – Auditing and Assurance: Concepts and Applications 2

Audit Case – Audit of Noncurrent Liabilities

Instruction: Work with your groups. Prepare audit working papers based on the case information. Be able
to answer the questions that follow. Summarize your answers in this MS Word document and present
your solutions, findings, and proposed adjustments in an MS Excel worksheet.

For the year ended December 31, 2020, you were assigned to audit Zed Foods Corporation, a company
produces candies and sweets. You are asked by your senior to perform procedures on liability accounts.
Based on your inquiries with your client and understanding of the business, you were able to gather the
following:
GL Acct
GL Acct Title Dr. (Cr.)
Code
20131 Due to BIR - w/holding tax - compensation (43,000.00)
20132 Due to BIR - w/holding tax - expanded (281,552.63)
20133 Due to BIR - w/holding tax - final (67,554.02)
20134 Due to BIR - VAT payable -
20135 Due to BIR - income tax payable (165,282.93)
20135 Due to PHIC (18,695.43)
20136 Due to SSS (47,899.25)
20200 Customer advances (115,000.00)
20340 Input tax 339,618.55
20350 Output tax (746,320.40)
21212 Bank loans - short-term (125,000.00)
21311 Bank loans - long-term - current -
21312 Bank loans - long-term - noncurrent (1,000,000.00)
21411 Bonds payable – current portion -
21412 Bonds payable – noncurrent portion (2,000,000.00)
22110 Provision for contingencies - current -
22112 Provision for contingencies - noncurrent -
23010 Lease obligation - current -
23020 Lease obligation - noncurrent ???
10890 Deferred tax assets 205,500.00
24010 Deferred tax liabilities (41,400.00)
10290 Allowance for credit losses (260,000.00)
10430 Purchases omitted
10499 Supplies omitted
10560 Fixed assets - clearing omitted
10730 Right-of-use assets ???
30010 Ordinary share capital, P10 par omitted
30410 Additional paid-in capital – convertible bonds ???
52181 Interest expense omitted
60110 Loss on contingencies - litigations omitted
60111 Other gains/losses omitted

LOANS AND LEASES

 The short-term loan is a 90-day, 4.5% term loan obtained from a local bank on November 1, 2020
to support working capital needs. The principal amount of P125,000 and the interest are payable
on January 30, 2021. No accrual for interest had been made as of December 31, 2020.
 On September 1, 2020, the company obtained a P1-million term loan to finance acquisition of
plant assets. It is payable on semi-annual installments at 5.5% interest p.a. (effective interest is
2.75% semi-annually), every 180 days beginning February 28, 2021. No accrual for interest had
been made as of December 31, 2020.
Far Eastern University
Institute of Accounts, Banking, and Finance
Department of Accountancy
ACT1205 – Auditing and Assurance: Concepts and Applications 2

 On July 1, 2020, the company entered into a lease agreement for a warehouse and office space.
Excerpts from the lease contract follow:

Lease commencement July 1, 2020

Lease term Five years, with an option to extend for another five years
(Audit note: the management plans to install significant
improvements on the leased property with a useful life
extending beyond the initial five-year term. It is reasonably
certain that the management will exercise the option to
extend.)
Lease payments P1,500,000 annually in advance, starting lease
commencement, for the noncancelable five-year term

With escalation clause – increase of 20% in annual rent after

the noncancelable period; fixed for the next five-year term

No interest rate is implied in the agreement. However, it shows that Zed Foods can borrow
money at 5% to finance the acquisition of a similar property under the similar terms, with similar
collateral.

In addition, Zed Foods incurred P169,706.14 initial direct costs.

 On January 2, 2019, the Zed Foods Corporation issued P2,000,000 of 8% convertible bonds at
par. The bonds will mature on January 1, 2023 and interest is payable annually every January 1.
The bond contract entitles bondholders to receive 6, P100 par value, ordinary shares in exchange
for each P1,000 bond. On the date of issue, the prevailing interest rate for similar debt without the
conversion option is 10%. At the beginning of the current year, the holders of the bonds with total
face value of P1,000,000 exercised their conversion privilege. On that date, the bonds were
selling at 110 and the ordinary share at P42.

1. Propose AJEs to accrue interest on short-term and long-term bank loans and bonds payable.

GL Acct Code Description Debit Credit

       
       
       
Far Eastern University
Institute of Accounts, Banking, and Finance
Department of Accountancy
ACT1205 – Auditing and Assurance: Concepts and Applications 2
Far Eastern University
Institute of Accounts, Banking, and Finance
Department of Accountancy
ACT1205 – Auditing and Assurance: Concepts and Applications 2

2. Propose AJEs to take up current portion of long-term loans.

GL Acct Code Description Debit Credit

       
       
       

3. Propose AJEs to accrue interest on lease liability.

GL Acct Code Description Debit Credit

       
       
       

4. What adjustment, if any, should be proposed for bonds payable as at January 1, 2020?

GL Acct Code Description Debit Credit

       
       
       

5. What should be the journal entry as at January 1, 2020 to record the conversion of bonds into
ordinary shares?

GL Acct Code Description Debit Credit

       
       
       

6. How much is the increase in equity in 2019 related to the convertible bonds? ______________
7. How much is the increase in equity in 2020 related to the convertible bonds? ______________
8. How much should the Right-of-Use (ROU) asset be initially recognized? ______________
9. How much should be reported as ROU as of December 31, 2020? ______________
10. How much is the total lease liability as of December 31, 2020? ______________
11. How much should be presented under the line item “current portion of long-term debt and lease
obligation” in the financial statements as of December 31, 2020? ______________
12. How much should be presented under the line item “noncurrent portion of long-term debt and
lease obligation” in the financial statements as of December 31, 2020? ______________
13. How much should be presented under the line item “bonds payable” under the noncurrent
liabilities section of the statement of financial position as of December 31, 2020?
______________

PROVISIONS AND CONTINGENCIES

At the beginning of the year, the company had P500,000 provision for litigation related to an illegal
dismissal case. The same was settled during the year.
Far Eastern University
Institute of Accounts, Banking, and Finance
Department of Accountancy
ACT1205 – Auditing and Assurance: Concepts and Applications 2

On September 2020, the company was sued for a food poisoning case involving 20 schoolchildren.
Based on the reply of the external legal counsel handling the case, there is a high probability that the
company will be held liable for an amount ranging from P500,000 to P800,000.

On October 2020, the company was sued by one of its suppliers for a data privacy breach. Based on your
inquiries with the company’s external legal counsel, it is possible that the company may be held liable for
P1,000,000 in penalties and in damages, but the probability is just 20%.

14. Assuming that the timing of settlement of the above cases is expected to be beyond twelve
months from the reporting period, how much should be accrued as provision? Do not discount the
amount/s. ______________
15. Are there any contingent liabilities? If any, how much? What should be the proper treatment of
the latter in the financial statements?

INCOME TAXES

After all the adjustments above had been effected, the company had a pre-tax income of P1,384,276.43.
In the previous three quarters, the company has paid a total of P250,000 in income taxes. Hence, the
company has accrued income tax payable as follows:

However, the company failed to take into account the following permanent and temporary differences:

 Dividend income from a domestic corporation, exempt from income tax, P50,000.
 Interest earned from banks, already subjected to final withholding taxes, P47,364.20.
 Fines and penalties, P48,000.
 Nondeductible portion of interest expense, P7,111.48.
 Movements in the following accounts:
o Allowance for credit losses
 Beginning balance, P185,000
 Provision for bad debts, P100,000
 Write-offs evidenced by collection notices “returned to sender”, P25,000
o Provision for contingencies
 Beginning balance, settled during the year P500,000
 Provision recognized during the year, ??? (refer to #14)
o Customer deposits
 Beginning balance, P138,000
Far Eastern University
Institute of Accounts, Banking, and Finance
Department of Accountancy
ACT1205 – Auditing and Assurance: Concepts and Applications 2

 Deposits earned during the year, P70,000

 Deposits collected from customers during the year, to be applied on subsequent
year, P47,000

16. How much should be the correct current income tax expense for 2020? ______________
17. How much is the deferred income tax expense for 2020? ______________
18. How much should be presented as net deferred income tax asset/liability as of December 31,
2020? Apply offsetting. Indicate whether the amount is a net DTA or a DTL. ______________
19. Propose AJE to correct provision for income taxes – current.

GL Acct Code Description Debit Credit

       
       
       

20. Assume that a new effective tax rate is enacted which reduces the income tax rates from 30% to
25% was signed into law on March 2021, before the 2020 audited financial statements were
approved for release. This law is effective January 2021. Following the guidance from PAS 10,
Events After the Reporting Period and PAS 12, Income Taxes, determine whether the latter is an
adjusting or a non-adjusting event. Document this on your working papers and provide
recommendation as to what the company should do regarding its deferred income taxes.