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AUDITING PRACTICE OCAMPO/OCAMPO

AP.3408 - Audit of Equity MAY 2023

SUBSTANTIVE AUDIT OF EQUITY

Existence: Recorded equity accounts exist Valuation and allocation: Shareholders’ equity balances
are shown at appropriate amounts.
1. Obtain schedules of shareholders’ equity accounts and
reconcile to the general ledger balances. 9. Vouch share capital entries, dividend entries and
entries to retained earnings.
2. Review authorization and terms of share issues.

3. Confirm shares outstanding with registrar on share and Presentation and disclosure: Shareholders’ equity
transfer agent. accounts are properly presented and adequately disclosed
in the financial statements.
4. Inspect share certificate book.
10. Review financial statements and perform analytical
procedures to determine whether accounts are
5. Inspect certificates of shares held in treasury.
classified and disclosed in the financial statements in
accordance with GAAP.
Completeness: All equity accounts are recorded
11. Review minutes of board of directors’ and
6. In addition to the above-mentioned procedures, shareholders’ meetings for share options and dividend
perform analytical review procedures. restrictions.

Rights and obligations: the entity has the authority to

execute the shareholders’ equity transactions
7. Review articles of incorporation and by laws.

8. Make inquiries of legal counsel.

INTERNAL CONTROL MEASURES

1. Internal control measures regarding the issuance of share certificates and proper accounting for transfers and
registration of shares should be established. One of these measures is the appointment of a share and transfer agent
or an independent registrar.

2. Share certificates should be serially prenumbered by the printer and that the authority for signing and issuing the
certificates be designated by the board of directors.

3. As individual certificates are issued, corresponding records of the certificates should be prepared containing the name
and address of the shareholders and the number of shares issued to each.

4. Cancelled certificates should be mutilated and any necessary documentary stamps should be attached to the
cancelled certificates.

5. Entries for the share issuances and transfers should be made by a person who does not have authority to sign and
issue certificates.

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PROBLEM NO. 1 REQUIRED:

With your representation, as Managing Partner of the Sy 1. Prepare adjusting entries as of Dec. 31, 2022.
Pee Ey & Co., your firm was engaged in the audit of the 2. Based on the above and the result of your audit,
Fortitude Company at the close of the company’s first determine the adjusted balances of the following as of
year of operations on Dec. 31, 2022. The company closed Dec. 31, 2022.
its books prior to the time you began your year-end a. Share capital
fieldwork. b. Share premium
c. Total retained earnings
Your audit and review showed the following shareholders’ d. Total shareholders’ equity
equity accounts in the general ledger:
3. In an examination of shareholder’s equity, an auditor
Share Capital
is most concerned that
08/30 CD P550,000 01/02 CR P6,000,000
a. Capital stock transactions are properly authorized.
12/29 J 545,000 b. Stock splits are capitalized at par or stated value
on the dividend declaration date.
Retained Earnings c. Dividends during the year under audit were
12/29 J P545,000 12/01 CR P287,500 approved by the shareholders.
12/31 J 4,000,000 d. Changes in the accounts are verified by a bank
serving as a registrar and stock transfer agent.

P/L Summary 4. In audit of a medium-sized manufacturing concern,

12/31 J P26,000,000 12/31 J P30,000,000 which one of the following areas can be expected to
12/31 J 4,000,000 require the least amount of audit time?
a. Owner’s equity c. Revenue
Based on the other working papers submitted by your b. Assets d. Liabilities
audit staff, the following additional information was
forwarded: 5. When a corporate client maintains its own stock
records, the auditor primarily will rely upon
From the Articles of Incorporation of Fortitude Company: a. Confirmation with the company secretary of shares
• Authorized share capital – 150,000 shares outstanding at year-end.
• Par value per share – P100 b. Review of the corporate minutes for data as to
shares outstanding.
From the board of directors’ minutes of meetings, the c. Confirmation of the number of shares outstanding
following resolutions were extracted: at year-end with the appropriate state official.
d. Inspection of the stock book at year-end and
• 01/02 – authorized the issuance of 50,000 shares at accounting for all certificate numbers.
P120 per share.
• 08/30 – authorized the acquisition of 5,000 shares at 6. If the auditee has a material amount of treasury
P110 per share. shares on hand at year-end, the auditor should
• 12/01 – authorized the re-issuance of 2,500 treasury a. Count the certificates at the same time other
shares at P115 per share. securities are counted.
• 12/29 – Declared a 10% share dividend, payable Jan. b. Count the certificates only if the company had
31, 2023 to shareholders on record as of Jan. 15, treasury share transactions during the year.
2023. The market value of the share on Dec. 29, 2022 c. Not count the certificates if treasury share is a
was P130 per share. deduction from shareholders’ equity.
d. Count the certificates only if the company classifies
treasury shares with other assets.

PROBLEM NO. 2
The Retained Earnings account of Endurance Company shows the following debits and credits for the current year:
RETAINED EARNINGS
Balance
Date Debit Credit Debit Credit
Jan. 1 Balance 726,400
(a) Loss from fire 5,250 721,150
(b) Write-off of goodwill 52,500 668,650
(c) Share dividends distributed 140,000 528,650
(d) Loss on sale of equipment 48,300 480,350
(e) Officers’ compensation related to income of prior
periods – accrual overlooked 325,500 154,850
(f) Loss on retirement of preference shares at more
than issue price 70,000 84,850
(g) Paid in capital in excess of par 129,500 214,350
(h) Share issuance expenses (related to letter g) 10,000 204,350
(i) Share subscription defaults 8,470 212,820
(j) Gain on retirement of preference shares at less than
issue price 25,900 238,720
(k) Gain on early retirement of bonds 15,050 253,770
(l) Gain on life insurance policy settlement 10,500 264,270

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RETAINED EARNINGS
Balance
Date Debit Credit Debit Credit
(m) Correction of a fundamental error 50,050 314,320
(n) Effect of change in accounting principle from FIFO to
weighted average 100,000 414,320
(o) Dividends payable 25,000 389,320
(p) Loss on sale of treasury shares 20,000 369,320
(q) Proceeds from sale of donated shares 40,000 409,320
(r) Appraisal increase in land 250,000 659,320
(s) Appropriated for property acquisition 100,000 559,320

REQUIRED:
1. Prepare adjusting journal entries to correct the 4. The auditor is concerned with establishing that
Retained Earnings account. dividends are paid to client corporation shareholders
owning shares as of the
2. Determine the correct amount of Retained Earnings a. Issue date c. Declaration date
account before closing profit or loss for the period. b. Record date d. Payment date

3. An audit program for the retained earnings account 5. During an audit of an entity’s shareholders’ equity
should include a step that requires verification of the accounts, the auditor determines whether there are
a. Fair value used to charge retained earnings to restrictions on retained earnings resulting from loans,
account for a two-for-one-share split. agreements, or law. This audit procedure most likely
b. Approval of the adjustment to the beginning is intended to verify management’s assertion of
balance as a result of a write-down of an account a. Existence
receivable. b. Valuation
c. Authorization for both cash and share dividends. c. Completeness
d. Gain or loss resulting from disposition of treasury d. Presentation and disclosure
shares.

PROBLEM NO. 3
Resilience Corporation was organized on Jan. 1, 2020, and began operations immediately. Unfortunately, the company
hired an incompetent bookkeeper. For the years 2020 through 2022, the bookkeeper presented an annual balance sheet
that reported only one amount for shareholders' equity: 2020, P1,377,000; 2021, P1,566,000 and 2022, P1,850,000.
Also, the condensed income statement reported as follows: 2020, net loss, P175,000; 2021, net profit, P220,000; and
2022, net profit, P409,300 (cumulative earnings of P454,300). Based on the P454,300, the president has recommended
to the board of directors that a cash dividend of P450,000 be declared and paid during Jan. 2023. The outside director on
the board has objected on the basis that the company's financial statements contain major errors (there has never been
an audit). You have been engaged to clarify the situation. The single shareholders' equity account, provided by the
bookkeeper, appeared as follows:
Shareholders' Equity
2020 Share issue costs P 13,000 2020 Ordinary shares, par P5
2020 Net loss 175,000 200,000 shares issued P1,600,000
2021 Bought 1,000 shares from an unhappy 2021 Net profit (including P100,000
shareholder Ekis 7,000 land write-up based on
president’s estimate) 220,000
Depreciation expense* 2021 Ordinary shares, 2,000
(2020, P15,000; 2021, P17,000; 2022, shares issued 18,000
P23,000) 55,000
Miscellaneous expenses* 2022 Sold 300 of the Ekis shares 2,700
(2020, P20,000; 2021, P25,000; 2022,
P5,000) 50,000
2022 Cash loan to the company president 100,000 2022 Net profit 409,300
P400,000 P2,250,000
* Recorded as expense but not shown on the income statement.

QUESTIONS:
Based on the concerns of the outside director, you must address the following questions:
1. What is the adjusted balance of retained earnings as of Dec. 31, 2022?
2. What entry is necessary (a) to close the above single shareholders' equity account and (b) to record the various
components of shareholders' equity in separate accounts?
3. What is the adjusted total equity as of Dec. 31, 2022?

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PROBLEM NO. 4
Hawks Corporation was incorporated in 2021. During
2021, the company issued 100,000 shares of P1 par value
ordinary shares for P27 per share. During 2021, Hawks
Corporation had a profit of P250,000 and paid dividends of
P28,000.

During 2022, the company had the following transactions.

1/2 Issued 10,000 shares of P100 par value

cumulative preference shares at par. The
preference shares are convertible into five
ordinary shares and had a dividend rate of 6%.

3/1 Issued 3,000 ordinary shares for legal service

performed. The value of the legal services was
P100,000. The shares are actively traded on a
stock exchange and valued on 3/1 at P32 per
share.

7/1 Issued 40,000 ordinary shares for P42 per

share.

10/1 Repurchased 16,000 treasury shares for P34 per

share.

12/1 Sold 3,000 treasury shares for P29 per share.

12/30 Declared and paid a dividend of P0.20 per share

on ordinary shares and a 6% dividend on the
preference shares.

During 2022 Hawks Corporation had a profit of P380,000.

QUESTIONS:
Based on the above and the result of your audit, determine
the following:
1. Total share premium as of Dec. 31, 2022
a. P4,333,000 c. P4,337,000
b. P1,733,000 d. P4,348,000
2. Total retained earnings as of Dec. 31, 2022
a. P516,000 c. P602,000
b. P501,000 d. P279,000
3. Total equity as of Dec. 31, 2022
a. P5,621,000 c. P5,535,000
b. P5,539,000 d. P5,550,000
4. Basic earnings per share for the year 2022
a. P2.11 c. P3.20
b. P1.60 d. P2.69
5. Diluted earnings per share for the year 2022
a. P1.90 c. P2.11
b. P1.48 d. P2.25

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