Assignment

I. You are retained by Columbia Corporation to audit its financial statements for the fiscal year ended June 30. Your consideration of internal control indicates a fairly satisfactory condition, although there are not enough employees to permit an extensive separation of duties. The company is one of the smaller units in its industry, but it has realized net income of about $500,000 in each of the last three years. Near the end of your fieldwork, you overhear a telephone call received by the president of the company while you are discussing the audit with him. The telephone conversation indicates that on May 15 of the current year the Columbia Corporation made an accommodation endorsement of a 60-day $430,000 note issued by a major customer, Brill Corporation, to its bank. The purpose of the telephone call from Brill was to inform your client that the note had been paid at the maturity date. You had not been aware of the existence of the note before overhearing the telephone call.

a. From an ethical standpoint, do you think the auditors would be justified in acting on information acquired in this manner?
b. Should the balance sheet as of June 30 disclose the contingent liability? Give reasons for your answer.
c. Prepare a list of auditing procedures that might have brought the contingency to light.
d. Explain fully the likelihood of detection of the accommodation endorsement by each procedure listed.

II. You are engaged in the audit of the financial statements of Holman Corporation for the year ended December 31, 20X6. The accompanying analyses of the Property, Plant, and Equipment and related accumulated depreciation accounts have been prepared by the chief accountant of the client. You have traced the beginning balances to your prior year's audit working papers.

Holman Corporation

Analysis of Property, Plant, and Equipment and Related Accumulated Depreciation Accounts

Year Ended December 31, 20X6

Final                       Assets                   Per Ledger

Description            12/31/X5 Additions Retirements12/31/X6

Land                       $422,500 $ 5,000 $427,500

Buildings                                120,000   17,500                                     137,500

Machinery and equipment 385,000 40,400 $26,000 399,400

$927,500                 $62,900   $26,000                  $964,400

FinalAccumulated DepreciationPer Ledger

Description 12/31/X5             Additions     Retirements12/31/X6

Buildings                                $ 60,000  $ 5,150                                   $ 65,150

Machinery and equipment 173,250     39,220                                    212,470

$233,250 $44,370                                  $277,620

*Depreciation expense for the year.

All plant assets are depreciated on the straight-line basis (no residual value taken into consideration) based on the following estimated service lives: building, 25 years; and all other items, 10 years. The company's policy is to take one half-year's depreciation on all asset additions and disposals during the year.

Your audit revealed the following information:

1. On April 1, the company entered into a 10-year lease contract for a die casting machine, with annual rentals of $5,000 payable in advance every April 1. The lease is cancelable by either party (60 days' written notice is required), and there is no option to renew the lease or buy the equipment at the end of the lease. The estimated service life of the machine is 10 years with no residual value. The company recorded the die casting machine in the Machinery and Equipment account at $40,400, the present value at the date of the lease, and $2,020 applicable to the machine has been included in depreciation expense for the year.

2. The company completed the construction of a wing on the plant building on June 30. The service life of the building was not extended by this addition. The lowest construction bid received was $17,500, the amount recorded in the Buildings account. Company personnel constructed the addition at a cost of $16,000 (materials, $7,500; labor, $5,500; and overhead, $3,000).

3. On August 18, $5,000 was paid for paving and fencing a portion of land owned by the company and used as a parking lot for employees. The expenditure was charged to the Land account.

4. The amount shown in the machinery and equipment asset retirement column represents cash received on September 5 upon disposal of a machine purchased in July 20X2 for $48,000. The chief accountant recorded depreciation expense of $3,500 on this machine in 20X6.

5. Harbor City donated land and a building appraised at $100,000 and $400,000, respectively, to Holman Corporation for a plant. On September 1, the company began operating the plant. Since no costs were involved, the chief accountant made no entry for the above transaction.

Prepare the adjusting journal entries that you would propose at December 31, 20X6, to adjust the accounts for the above transactions. Disregard income tax implications. The accounts have not been closed. Computations should be rounded off to the nearest dollar. Use a separate adjusting journal entry for each of the preceding five paragraphs.