ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 41 Ÿ May 2021 CPA Licensure Examination Ÿ Week No. 9

AUDITING (Auditing Problems) S. Ireneo Ÿ C. Espenilla

AP-301: LEASES; INCOME TAXES; POST-RETIREMENT BENEFITS

PROBLEM 1:

CASE 1:
On September 1, 2018, Mansion Company entered into one-year nonrenewable lease, commencing on
that date, for an office space and made the following payments to ABC Properties:
Bonus to obtain lease 120,000
First month’s rent 40,000
Last month’s rent 40,000
If the lease is considered “Short-term lease” in its income statement for the year ended Dec. 31, 2018,
what amount should Mansion report as rent expense?
CASE 2:
On January 1, 2018, Travel Corporation signed an 3-year operating lease for various office furniture and
equipment at P300,000 per year. The lease included a provision for additional rent of 5% of annual
company sales in excess of P2,000,000. Travel’s sales for the year ended Dec. 31, 2018 were
P2,500,000. Upon execution of the lease, Travel Corporation paid P100,000 as a bonus for the lease. If
the lease is considered “Low value lease”, Travel’s rent expense for the year ended Dec. 31, 2018 is
CASE 3:
As an inducement to enter a lease, Premier Arts Company, a lessor, grants Marvel Management
Corporation, a leaseholder, nine months of free rent under a two-year operating lease for its office
furniture and equipment. The lease is effective on Feb. 1, 2018 and provides for monthly rental of
P30,000 to begin November 1, 2018. If the lease is considered “Low value lease”:
1. What is the rent expense for 2018?
2. What amount of accrued rent should Marvel report in its Dec. 31, balance sheet?

PROBLEM 2:

On January 1, 2017, DEF Corp. leased an equipment for 3 years at an annual rental of P500,000 payable
every January 1 starting at inception. The equipment had an estimated useful life of 5 years with the
asset ownership to be transferred to the lessee at lease expiration. The lessee paid lease bonus
amounting to P300,000 and direct lease expense which included installation and commissioning costs
amounting to P200,000. The lessor will however reimburse DEF Corp. 40% of the direct lease expense as
a lease incentive. DEF Corp. further estimated that it will incur P600,000 in the future as cost to dismantle
and decommission the said equipment upon retirement. The implicit lease rate on the lease known to both
parties at the lease inception which is also deemed relevant in the determination of the present value of
any future retirement obligations is at 8%. The asset had an estimated salvage value of P400,000 after 3
years and P200,000 after 5 years.
Requirements:
1. Initial cost of the Right of Use Asset
2. Interest expense on the lease liability for 2017
3. Interest expense on the provision for asset retirement in 2017
4. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method)

PROBLEM 3:

On January 1, 2017, GHI Corp. leased an equipment for 3 years at semi-annual rental of P500,000
payable every June 30 and December 31. The equipment had an estimated useful life of 5 years. GHI
Corp. has an option to purchase the equipment from the lessor by paying the lessor P400,000 at the lease
expiration date. The lessee paid lease bonus amounting to P400,000 and direct lease expense which
included installation and commissioning costs amounting to P300,000. The lessor will however reimburse
GHI Corp. 20% of the direct lease expense as a lease incentive.
The annual implicit lease rate on the lease known to both parties at the lease inception was at 10% while
the incremental borrowing rate of the GHI Corp. was at 12%. The asset had an estimated salvage value of
P300,000 after 3 years and P100,000 after 5 years.
Requirements:
If at lease inception, GHI Corp. is reasonably certain to exercise the purchase option:
1. Initial cost of the Right of Use Asset
2. Interest expense on the lease liability for 2017
3. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method)
4. Entry to record the exercise of the purchase option at the lease expiration
5. Entry to record the non-exercise of the purchase option at the lease expiration

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-301
Week No. 9: LEASE, INCOME TAXES, POST-EMPLOYMENT BENEFITS

PROBLEM 4:

Using the same information in the previous problem however, assuming that at lease inception, GHI Corp.
is not reasonably certain to exercise the purchase option:
Requirements:
1. Initial cost of the Right of Use Asset
2. Interest expense on the lease liability for 2017
3. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method)

PROBLEM 5:

On January 1, 2017, JKL Corp. leased a building for 4 years at semi-annual rental of P800,000 payable
every January 1 and July 1 starting at the lease inception. The equipment had an estimated useful life of
6 years. The annual implicit lease rate on the lease known to both parties at the lease inception was at
12%. The asset had an estimated salvage value of P300,000 after 4 years and P100,000 after 6 years.
JKL Corp. guaranteed the residual value of the asset.
Requirements:
1. Initial cost of the Right of Use Asset
2. Interest expense on the lease liability for 2017
3. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method), assuming that the
asset’s estimated residual value remains P300,000 at the end of 2017.
4. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method), assuming that the
asset’s estimated residual value was revised to P400,000 by the end of 2017.
5. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method), assuming that the
asset’s estimated residual value was revised to P100,000 by the end of 2017.
6. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method), assuming that the
asset’s estimated residual value was revised to zero by the end of 2017.

PROBLEM 6:

Using the information in the previous problem except that assuming that JKL did not guarantee the
asset’s residual value.
Requirements:
1. Initial cost of the Right of Use Asset
2. Interest expense on the lease liability for 2017
3. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method), assuming that the
asset’s estimated residual value remains P300,000 at the end of 2017.

PROBLEM 7:

On January 1, 2017, MNO Corp. leased a building for 5 years at an annual rental of P600,000 payable
every December 31. The building had an estimated useful life of 15 years. The annual implicit lease rate
on the lease known to both parties at the lease inception was at 12%. The lease agreement contained an
option for MNO Corp. to extend the lease for another 10 years but at a reduced annual rental of
P500,000.
At lease inception, it was reasonably certain that MNO Corp. will be exercising the option.
Requirements:
1. Initial cost of the Right of Use Asset
2. Interest expense on the lease liability for 2017
3. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method).

PROBLEM 8:

Using the same information in the previous problem, assuming however that at lease inception it was not
reasonably certain that MNO Corp. will be exercising the option.
Requirements:
1. Initial cost of the Right of Use Asset

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-301
Week No. 9: LEASE, INCOME TAXES, POST-EMPLOYMENT BENEFITS

2. Interest expense on the lease liability for 2017

3. Depreciation expense on the Right of Use Asset in 2017 (Straight Line Method).
4. Assuming that at the beginning of 2019 the lessee decided that it will certainly exercise the lease
extension option, what is the revised Carrying Value of the Lease Liability, January 2019 and the
interest expense on Lease Liability in 2019?
5. Assuming that at the beginning of 2019 the lessee decided that it will certainly exercise the lease
extension option, what is the revised Carrying Value of the Right of Use Asset, January 2019 and
the depreciation expense on the Right of Use Asset in 2019?

PROBLEM 9:

ABC Co. reported net income for the current year 2018 at P10,000,000 before taxes. Included in the
determination of the said net income were:
Fines, penalties and surcharges P20,000
Life insurance expense 30,000
Goodwill impairment 50,000
Interest income subject to final tax 100,000
Royalty income subject to final tax 150,000
Dividend income from a domestic corporation 120,000
Life insurance settlement income 130,000
Accrued warranty expense 550,000
Commission payments made in advance 400,000
Advance rent collections 500,000
Provisions for probable losses arising from lawsuits 900,000
Accrued service income 300,000

The income tax rate is 40% and is not expected to change in the future.
Required:
1. How much is the current tax expense?
2. How much is the total tax expense?
3. What is the total deferred tax asset to be presented in the 2018 Statement of Financial Position?
4. What is the total deferred tax liability to be presented in the 2018 Statement of Financial Position?
5. Assuming expected income tax rate for the following year is 35%, what is the total tax expense?
6. Assuming expected income tax rate for the ff. year is 35%, what is the total deferred tax liability?
7. Assuming expected income tax rate for the ff. year is 35%, what is the total deferred tax asset?

PROBLEM 10:

XYZ Co. reported net income for the current year 2018 at P5,000,000 before taxes. Included in the
determination of the said net income were:
Permanent differences
Non-deductible expenses P150,000
Non-taxable income 50,000
Temporary differences at the beginning of the year:
Cumulative temporary difference creating
future deductible amount P1,200,000
Cumulative temporary difference creating
Future taxable amount 800,000
Temporary differences at the end of the year:
Cumulative temporary difference creating
future deductible amount P1,600,000
Cumulative temporary difference creating
Future taxable amount 500,000
The income tax rate is 40% and is not expected to change in the future.
Required:
1. How much is the current tax expense?
2. How much is the total tax expense?
3. What is the total deferred tax asset to be presented in the 2018 Statement of Financial Position?
4. What is the total deferred tax liability to be presented in the 2018 Statement of Financial Position?

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY AP-301
Week No. 9: LEASE, INCOME TAXES, POST-EMPLOYMENT BENEFITS

PROBLEM 11:

You are auditing Japs Corp.’s post-retirement benefits accounts. The following selected accounts were
lifted from the 2018 unadjusted trial balance. No adjusting entry had been made yet at year end in
relation the post-retirement benefits related accounts.

Accrued Pension Expense, January 1, 2018 P630,000

Pension expense for 2018, amount contributed to the plan 1,200,000

Additional information:
The memorandum account balances and other off-books transactions are as follows:
Plan asset at fair market value, January 1, 2018 P9,450,000
Accumulated benefit obligation at present value, January 1, 2018 10,080,000
Payments to retirees at scheduled retirement in 2018 1,400,000
Payments to early retirees (settlement price) in 2018 800,000
Carrying value of accrued benefits of early retirees in 2018 650,000
Current service cost 855,000
Past service cost recognized in the current year 120,000
Settlement rate 12%
Plan asset at fair market value, December 31, 2018 9,800,000
Accumulated benefit obligation at present value, December 31, 2018 10,500,000

There had been no remeasurement (actuarial) gain or loss from plan asset and accumulated retirement
obligation in the prior years.

Required:
1. What is the total pension expense in 2018?
2. How much from the pension expense is recognized in the 2018 profit or loss?
3. How much from the pension expense is recognized in the 2018 other comprehensive income or
loss?
4. What is the accrued pension liability as of December 31, 2018?

PROBLEM 12:

You are auditing Ireland Corp.’s post-retirement benefits accounts. The following selected accounts were
lifted from the 2018 unadjusted trial balance. No adjusting entry had been made yet at year end in
relation the post-retirement benefits related accounts.

Prepaid Pension Expense, January 1, 2018 P220,000

Pension expense for 2018, amount contributed to the plan 750,000

Additional information:
The memorandum account balances and other off-books transactions are as follows:
Plan asset at fair market value, January 1, 2018 P3,200,000
Accumulated benefit obligation at present value, January 1, 2018 2,980,000
Payments to retirees at scheduled retirement in 2018 560,000
Current service cost 480,000
Settlement rate 8%
Actuarial loss on plan asset 80,000
Actuarial loss on accumulated benefit obligation 30,000

There had been no remeasurement (actuarial) gain or loss from plan asset and accumulated retirement
obligation in the prior years. The asset ceiling at the beginning and at the end of the year was at
P250,000 and P350,000, respectively.

Required:
1. What is the total pension expense in 2018?
2. How much from the pension expense is recognized in the 2018 profit or loss?
3. How much from the pension expense is recognized in the 2018 other comprehensive income or
loss?
4. What is the prepaid pension expense as of December 31, 2018?

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