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nd
Flr, GF Partners Bldg, 139 H.V. dela Costa, Salcedo Village, Makati City
AUDITI NG PROBLEMS
Accounti ng for Changes and Correction of Errors Prof . L.O.
Aristorenas
__
Defi ni ti on of Ters
Accounti ng !o"icies # specific principles, bases, conventi ons,
rules and practices adopted by an enterprise in preparing and presenti ng the
financial statements.
$undaent a" errors # are errors discovered in the current period
with such significance, that the financial statements of one or more prior
periods can no longer be considered to have been reliable at the date of their
issue.
Reasons %h& Accounti ng Changes Occur :
1. he accounti ng profession may mandate that a new accounti ng principle is to
be used.
!. "hanging economic condi tions
#. "hanges in technology and in operations
$. %ew e&perience or new informat i on may prompt companies to change its
esti mate of revenues or e&penses.
T'PES O$ ACCOUNTI NG C(ANGES
)* Change in Accounti ng Princi!" es
his is a change from one generall y accepted accounting principle to another
generall y accepted accounting principle. Adoption of a new principle in recogni tion
of events that have occurred for the 1st ti me is not a change in accounti ng
principle. here is no change in accounting principle when the depreciati on method
adopted for a newl y ac'uired asset is different from the method or methods used
for previousl y recorded assets of similar class.
A change from a principle that is not generall y accepted to one that is
generall y accepted is considered to be an error correction than a change in
accounti ng principle.
Accounti ng Procedure+
Benchar, treat ent
A change in accounti ng policy(pri nci ple should be applied retroacti vel y unless
the amount of any resulting ad)ust ment that relates to prior periods is not
reasonabl y determi nable. Any resulting ad)ust ment should be reported as an
ad)ust ment to the opening balance of the retained earnings. "omparati ve
informat i on should be restated unless it is impracticable to do so.
-* Change in Accounti ng Esti at e
his is a change that occur as a result of new informat i on or ac'uisition of
additional e&perience. "hanges in esti mates are viewed as normal recurri ng
corrections and ad)ust ments or the natural result of the accounti ng process.
*etroacti ve treat ment is prohibi ted.

Accounti ng Procedure+
a. *eport current and future financial statements on the new basis.
1
b. Present prior period financial statements as previousl y reported.
c. +a,e no ad)ust ment to current period opening balances.
NOTE+ -henever it is impossible to determi ne whether a change in principle
or a change in esti mate has occurred, or if an asset is affected by both a change in
principle and a change in esti mate during the same period, the change should be
accounted for as a change in esti mate rather than a change in principle.
CORRECTION O$ ERRORS
%o company whether large or small is immune from errors. .rrors may be
intenti onal or unintenti onal. /ntentional errors are significant because of the
presence of fraud or intent to deceive. hese errors are made for the purpose of
concealing fraud or misappropriati on, evading ta&es, manipulati ng or window0
dressing the company1 s financial statements. 2nintenti onal errors were not
deliberatel y commi t t ed. hey result from carelessness or ignorance on the part of
the company1 s personnel or it may result from poor internal control.
he ris, of material errors may be mini mi3ed through the installation of good
internal control and the application of sound accounti ng procedures. Prior period
ad)ust ments, also called fundament al errors are reported in the current year as
ad)ust ment in the beginni ng balance of the *etained .arnings account. Prior period
statements should be restated to correct the error when comparati ve statements
are prepared.
Accounti ng Procedure+
1. /f detected in the period the error occurred, correct the accounts
through normal accounti ng cycle ad)ust ments.
!. /f detected in subse'uent period, ad)ust errors by ma,ing prior period
ad)ust ments directl y to *etained .arnings or restate the beginni ng
balance of the *etained .arnings account.
#. "orrect all previousl y presented prior period statements.
.&amples of Accounting errors:
a. A change from an accounting principle that is not generall y accepted to an
accounti ng principle that is generall y accepted.
b. +athemat ical mista,es
c. +ista,e in the application of accounti ng of accounting principle
d. Oversight
e. +isuse of facts
f. /ncorrect classification of e&pense as an asset or vice versa
g. "hanges in esti mates which are not prepared in good faith
T'PES O$ ERRORS
)* Ba"ance Sheet Errors
his type of error refers to improper classification of real accounts such as
assets, liabili ties or stoc,holders1 e'uit y accounts. hey have no effect on net
income
-* Incoe Stat eent Errors
his type of error affects only the presentati on of nominal accounts in the
/ncome 4tatement. /t involves the improper classification of revenues and
e&penses accounts, hence, only the details of the /ncome 4tatement are misstated.
A reclassifying entry is necessary only if the error is discovered in the same year it
is commi t t ed. /t has no effect on the 5alance sheet and in the /ncome 4tatement.
/f the error is discovered in a subse'uent year, no classification entry is necessary.
.* Co/i ned Ba"ance Sheet and Incoe Stat eent errors
his affects both the balance 4heet and the /ncome 4tatement because
they result in the misstatement of net income.
2
C"assificati ons of Co/i ned Ba"ance Sheet and Incoe Stateent Errors+
a* Count er Ba"ancing Errors
.rrors which if not detected are automat icall y offset or corrected over
two periods. Restat ement is necessary even if a correcti ng
journal entry is not requi red.
Effect+ %et /ncome of two successive periods are misstated. he
amount of misstatement in one period is e'ual to but opposite in effect
in the income of the ne&t period.
"ounterbalanci ng errors include the misstatements of the followi ng
accounts:
1. /nventories to include the followi ng
a. Purchases
b. 4ales
!. Prepaid e&penses
#. 6eferred /ncome
$. Accrued e&pense
7. Accrued /ncome
GUIDELINES
5oo,s are open
1. /f the error is already counterbalanced and the company is in
the second year, an entry is necessary to correct the current
period and to ad)ust the beginning balance of the *etained
earnings.
!. /f the error is not yet counterbalanced, an entry is necessary to
ad)ust the beginni ng balance of the *etained earnings and
correct the current period.
5oo,s are closed
1. /f the error is already counterbalanced, no entry is necessary.
!. /f the error is not yet counterbalanced, an entry is necessary to
ad)ust the present balance of the *etained earnings.
/* Non Count er Ba"ancing Errors
.rrors which ta,e longer than two periods to correct themselves. his
type of error is carried over to the subse'uent accounti ng period until
corrected or until the balance sheet item involved is removed from the
accounts by sales, retirement or other means of disposal.
GUIDELINES IN ERROR ANAL'SIS
1. -hat accounts are affected8
!. 9ow were these accounts affected8 -as there an understatement or an
overstatement8
#. -hat was the erroneous entry made or what was the entry omi tted8
$. -hat is the correct entry8
7. -hat is the necessary ad)usti ng or correcti ng entry8
END
PROBLEM )
/n your e&ami nation of the financial statements of :*/49A+ "O*P., for the
year ended 6ecember #1, !;;$, you discovered the following errors. Prepare the
necessary ad)usting entries.
1. /nterest collection from a notes receivable amounti ng to P#,7;; which was
received on 6ecember #;, !;;$ was deposited and recorded on the same
day by a credi t to sales.
3
!. A staled chec, of P1!,;;; which had been outstandi ng for more than si&
months was included in the list of outstandi ng chec,s. his was in payment
of Accounts Payable
#. Payment of P$,7;; for freight charges on merchandise purchased on
6ecember 1<, !;;$ was debited to freight out account.
$. On 6ecember #1, !;;#, the physical count was overstated by P7,;;;.
7. /mprovements on building of P1;;,;;; had been charged to e&pense on
=anuary ;1, !;;$. /mprovements have a life of 7 years.
>. :*/49A+ "O*P. issued 7,;;; shares of P 1;; par value capital stoc, for
P77;,;;; on =anuary 1$, !;;#. he proceeds were credited to the "apital
4toc, account.
?. On =anuary ;1, !;;$, an e'uipment costing P?;,;;; was sold for P#7,;;;. At
the date of sale, the e'uipment has an accumulated depreciation of P$#,?7;.
he cash received was recorded as other income in !;;$.
<. A P17,;;; collection from 4mart "o. was correctl y recorded in the general
ledger but was erroneousl y credi ted to the subsidiary ledger account of
4murf "orp.
@. /nsurance premium of P$7,;;; for three years paid in =anuary !;;# was
charged to
e&penses in !;;#.
1;. On 6ecember #1, !;;#, goodwil l esti mated by the 5oard of 6irectors at
P#;;,;;; was set up by a credi t to *etained .arnings.
11. On 6ecember !@, !;;$, :*/49A+ "O*P. issued chec,s to its creditors
amounti ng to
P?7,;;;. hese chec,s were released on =anuary $, !;;7.
1!. A chec, for P!;,;;; from a customer to apply to his account was received on
6ecember
#;, !;;$ but was not recorded until =anuary $, !;;7.
1#. A customer1 s deposit of P>;,;;; for goods to be delivered in =anuary !;;7
was deducted from accounts receivable.
1$. A chec, was cleared by the ban, as P7,!;; on 6ecember ;7, !;;#, but was
recorded
by the boo,,eeper as P!,7;;. his was in payment of an employee cash
advance.
17. On the last day of !;;$, the company received a P@;,;;; prepayment from a
tenant for !;;7 rent of a building. /t was recorded as rent revenue.
PROBLEM -
/n early !;;7, while reviewi ng A.B/% /%".Cs !;;$ financial records, A.B/%
/%".s accountant discovered several errors. Dor each of the error listed below,
indicate the effect on net income for both !;;# and !;;$ and the necessary
ad)usting entries, assuming :
a. boo,s are still open
b. boo,s are already closed
1. A.B/% /%". fre'uentl y borrows from the ban, in order to maintain sufficient
operating cash. he following loans were at 1!E interest rate, with interest
payable at maturi t y. A.B/% /%". repaid each loan on its scheduled maturi t y date.
6A. OD LOA% A+O2% +A2*/F 6A.
11.;1.;# 7;,;;; 1;.#1.;$
;!.;1.;$ 17;,;;; ;?.#1.;$
;7.;1.;$ <;,;;; ;1.#1.;7
A.B/% /%". records interest e&pense when the loans are repaid. As a result,
interest
e&pense of P17,;;; was recorded in !;;$
!. Pollution control devices costing P<$,;;; which is high in relation to the cost
of the original e'uipment, were installed in !;;# and were charged to repairs in
!;;#. he original e'uipment referred to has a remaining useful life of > years on
6ecember #;, !;;# and is being depreciated using the straight line method.
Assume ta& rate of #!E.
4
#. A.B/% /%". receives subscription payments for annual Gone yearH
subscripti ons to its maga3ine. Payments are recorded as revenue when received.
Amounts received but unearned at the end of each of the last three years are
shown below.
!;;! !;;#
!;;$
2nearned revenues P!$;,;;; P#;;,;;;
P#7!,;;;
A.B/% /%". failed to record the unearned revenues in each of the three
years.
$. A.B/% /%". has esti mated bad debts using the percentage0 of0 sales method
since their business began operations in !;;!. /nformat i on relating to bad debts
and sales is as follows:
.stimated 5ad
6ebt .&pense Actual
Fear 4ales GE of 4alesH 5ad 6ebts
!;;1 P <?,;;; P!,>1; P1,!;;
!;;! 1!#,;;; #,>@; !,<7;
!;;# 1$?,;;; $,$1; #,!!!
At the beginning of !;;$, A.B/% /%". proposes changing their esti mati on of
bad debt e&pense from # percent of sales to ! percent. 4ales for the year totaled
P1,>#;,;;; and actual bad debts amounted to P#,?!;. he company had already
made an ad)ust ment based on the old rate.
7. 5eginning merchandise inventory G=anuary ;1, !;;#H was understated by
P<,>$;.
>. +erchandise costing P!$,;;; was sold for P$;,;;; on 6ecember !@, !;;#
but the sale was recorded in !;;$. he merchandise was shipped DO5 shipping
point and was not included in ending inventory.
?. A one0 year note receivable of P@>,;;; was held by A.B/% /%". beginni ng
October 1, !;;#. Payment of the 1; percent note and accrued interest was received
upon maturi t y. %o ad)usti ng entry was made on 6ecember #1, !;;#.
<. .'uipment with a ten0 year life was purchased on =anuary 1, !;;#, for
P#@,!;;. %o depreciation e&pense was recorded during !;;# or !;;$. Assume that
the e'uipment has no salvage value and that A.B/% /%". uses the straight0 line
method for recording depreciati on.
@. A two0 year fire insurance policy was purchased on +ay 1, !;;#, for P7?,7;;.
he entire amount was debited to Prepaid /nsurance. %o ad)usting entry was made
in !;;# or !;;$.
1;. Accrued e&penses omit ted at the end of the year are P$#,;;; in !;;!,
P$#,;;; in !;;# and P@!,;;; in !;;$.
PROBLEM .
Fou have been engaged to audit the accounts of .D2 "O*P. for the first ti me
in !;;$. 6uring the audit you found the following:
'ear endi ng Dece/er .)
-00- -00. -001
Omissions from the boo,s:
a. Accrued e&penses, 6ec. #1 P1<,;;; P!?,;;;
P@,;;;
b. Accrued income, 6ec. #1 #,>;; $,;7; #,17;
c. Prepaid e&penses, 6ec. #1 1;<,;;; <1,;;;
7$,;;;
d. 2nearned income. 6ec. #1 #1,7;; !!,7;;
1#,7;;
RE2UIREMENTS+ a. Dor each number indicate the effect by wri ti ng O for
overstated, U for understated or 3 for no effect.
b. /ndicate the amount of over or under statement.
E$$ECT AMOUNT

__________________1. On !;;$ net income of the omission of both accrued e&pense


and
unearned income at the end of !;;!, !;;# and !;;$ when
considered together.
__________________!. On *etained .arnings after closing at 6ec. #1, !;;$ of the
omission unearned income at the end of !;;!, !;;# and !;;$.
__________________#. On wor,i ng capital at 6ecember #1, !;;$ of the omission of
accrued income at the end of !;;!, !;;# and !;;$ when
considered together.
__________________$. On wor,i ng capital at 6ec. #1, !;;$ of the omission of
unearned
income at the end of !;;!, !;;# and !;;$.
__________________7. On *etained .arnings after closing at 6ec. #1, !;;$ of the
omission
of accrued e&penses at the end of !;;!, !;;# and !;;$.
__________________>. On wor,i ng capital at 6ec. #1, !;;$ of the omission of
prepaid
e&penses at the end of !;;# and !;;$.
__________________?. On *etained .arnings after closing at 6ec. #1, !;;$ on the
omission
of prepaid e&penses at the end of !;;! and !;;#.
__________________<. On !;;# net income of the omission of accrued e&penses at
the
end of !;;!.
__________________@. On !;;$ net income of the omission of accrued income at
the
end of !;;!, !;;# and !;;$ when considered together.
__________________1;. On the !;;# net income of the omission of both accrued
income
and prepaid e&pense at the end of !;;! and !;;#.
__________________11. On the !;;$ net income of the omission of prepaid e&penses
at
the end of !;;# and !;;$.
__________________1!. On !;;$ net income of the omission unearned income at
the
end of !;;! and !;;#.
__________________1#. On *etained .arnings before closing at 6ec. #1, !;;! of the
omission of accrued income at the end of !;;!.
__________________1$. On the !;;$ net income of the omission of accrued e&penses
at
the end of !;;!, !;;# and !;;$ when considered together.
__________________17. On *etained .arnings after closing at 6ec. #1, !;;$ of the
omission of both accrued e&penses and unearned income at the
end !;;!, !;;# and !;;$ when considered together.
PROBLEM 1
An e&ami nati on of the accounti ng records of +ervyn "ompany for the year
ended 6ecember #1, !;;$ indicated that several errors were commi t t ed as follows:
1. Purchase of merchandise in the amount of P1;,>!7 in !;;# was not recorded
until the following year but was included in the year1s inventory.
!. /n August !;;$, an P<,?7; invoice for office supplies was charged to
purchases. Office supplies are e&pensed as purchased.
#. /nventory on 6ecember #1, !;;$ was overstated by P7>,!7;.
$. An e'uipment costing P1!7,;;; and with an accumulated depreciati on of
P?7,;;; was sold for ><,?7; on =anuary 1, !;;$. /n addition, depreciation
was recorded for the e'uipment for !;;$ at the rate of 1;E. Proceeds from
sale was credi ted to the .'uipment account.
7. Dootings and e&tensions showed that the inventory on 6ecember #1, !;;#
was overstated by P 7@,#?7.
!
>. 6epreciation of e'uipment costing P17,;;; bought on =une #;, !;;1 was
computed based on an esti mated useful life of < years. he engineers
esti mated that the useful life of the asset should be revised to 1; years
effective !;;$. he company still provided for depreciation based on the old
esti mate.
?. /nterest of P>,!7; on notes receivable was not recogni3ed on 6ecember #1,
!;;$.
<. 4ales on account of P!7,;;; in 6ecember !;;$ were recorded in !;;7.
@. a&es of P1<,?7; applicable for the fourth 'uarter of !;;# were paid and
charged to e&pense on =anuary !;, !;;$.
1;. A fully depreciated machinery was sold on 6ecember #1, !;;$ but the sale
was not recorded until !;;7. he proceeds from sales on this machinery
costing P$#?,7;; was P#1,!7;.
11. On 6ecember !;, !;;#, a cash advance of P#?,7;; from a customer was
received for goods to be delivered in =anuary !;;$. he amount of cash
received was credited to sales. he company1 s gross profit is !;E of cost.
1!. /nsurance premium for a three year period amounti ng to P17,;;; was
charged to e&pense on =anuary 1, !;;# and no ad)ust ment was made on year
end.
1#. A collection of P#1,!7; from a customer was received on 6ecember #1,
!;;$ but not recorded until =anuary $, !;;7.
1$. A customer1 s chec, of P<,?7; was returned by the ban, on %ovember #,
!;;$ due to lac, of sufficient funds. Ad)ustment was made the following
year.
17. 6epreciation computed on the building for the years !;;# and !;;$ was
overstated by P1!,7;; per year.
*ecords of +ervyn "ompany reported the following net /ncome.
!;;# P 7$>,<?7
!;;$ >!7,;;;
RE2UIREMENTS+
1. Prepare a wor,sheet showing the corrected income for !;;# and !;;$.
!. Prepare the necessary ad)usting entries on 6ecember #1, !;;$ assumi ng:
a. 5oo,s are still open
b. 5oo,s are closed
Pro/" e 4
/n early !;;7, while reviewi ng 9O+A4 "O*P.1s !;;$ financial records, its
accountant discovered several errors. Dor each of the error listed below, indicate
the effect on net income for both !;;# and !;;$ assuming no correction was
made and the company uses the periodic system of inventory.
1. :oods shipped to consignee amounti ng to P!,7;; in !;;# were reported as
sales. :oods in the hands of the consignee at the end of !;;# were not
recogni3ed for inventory purposes. 4ale of such goods in !;;$ and
collections on such sales were recorded as credi ts to receivables established
with consignees in !;;#.
!. /nsurance costs incurred amounti ng to P17,;;; but unpaid in !;;# were not
recorded until paid in !;;$.
#. he total of one wee,1s sales amounti ng to P!,!7; in !;;# was credited to
:ain on sales0 +achineries
$. !;;# year end purchases of P1;,;;; were not recorded until the beginni ng
of !;;$. he inventory associated with these purchases was omi tted from
the ending inventory count in !;;#.
7. +achinery was sold in +ay of !;;$, but the company continued to deduct
depreciation for the remai nder of !;;$ although the asset was removed from
the boo,s in +ay. "ost of the asset purchased in October of !;;1 was
P1!,7;; and esti mated to have a useful life of 1; years, he company
follows the straight line method of computi ng depreciation.
"
>. A chec, of P>,!7; for =anuary !;;$ rent was received and recorded as
revenue at the end of !;;#.
?. !;;# year end purchase of P?,7;; of inventory were not recorded until the
beginning of !;;$ although the inventory was correctl y counted at the end of
!;;#.
<. /nterest receivable of P1,7;; in !;;# was not recorded until !;;$.
@. /nterest accrued of P$,;;; in !;;# on a note payable was not recorded until
it was paid in !;;$.
1;. "ertain items of ending inventory amounti ng to P7,<?7 were accidentall y not
counted at
the end of !;;#.
11. :oods sold on account in !;;# amounti ng to P7,;;; were not recorded as
sales until !;;$.
1!. %o depreciation amounti ng to P$,#?7 was ta,en in !;;# for e'uipment sold
in April !;;#. he company reports on a calendar year basis and computes
depreciation to the nearest month.
RE2UIREMENTS+ 6etermi ne the effect of the above mentioned errors on the
balance sheets and the income statement prepared in !;;# and !;;$ and
compute for the corrected income assuming reported income are as follows:
!;;# P 7;;,;;;
!;;$ #?7,;;;
Pro/" e 5
Dor three years, 5L2.5/*64 +64.. failed to recogni3e accruals, prepayments
and other transactions in its accounts. *eported net income and listing of the
error appear below:
-00- -00. -001
2nad)usted net income GlossH 17;,;;; 7;;,;;; G
1!7,;;;H
1. "hec,s written in 6ecember and mailed on =anuary #
of the followi ng year. !7; #?7 7;;
!. Overstatement of ending inventori es #>,;;; !<,;;; 0
#. Dailed to recogni3e unearned revenue 0 >,!7; 11,!7;
$. Dailed to record purchase on account and mdse
properl y included in ending inventory 0 0 7;,;;;
7. Dailed to recogni3e unused supplies at the end of year #,?7; 0 7,;;;
>. Dailed to record accrued commission e&penses !7,;;; #1,!7;
>;,;;;
?. 2nderstatement of depreciati on e&penses 17,;;; 1<,?7;
1<,?7;
<. -orthl ess accounts written not written off by year end >!7 ?7; <?7
@. Dailed to recogni3e gain on sale of landI Land credi ted for
the proceeds ?7,;;;
1;. Dailed to record accrued salaries 1>,!7; !!,7;; 0
Re6ui reent s+ Prepare a schedule to correct the reported net income for
each year and the ad)usting entries to correct the boo,s at the end of !;;$.
Pro/" e 7
1. +F4.*F4"O +A%2DA"2*/%: purchased a machine on =anuary 1, !;;; for
P7;,;;;. At the time, it was determi ned that the machine has an esti mated useful
life of 1; years and an esti mated residual value of P!,;;;. he company used the
double declining balance method of depreciation. On =anuary 1, !;;$, the company
decided to change its depreciation method from double declining balance to
straight line. he machine1s remaini ng useful life was esti mated to be 7 years with
a residual value of P 1,;;;.
#
!. %o allowance had been set up for esti mated uncollectible receivables. he
company decided to set up such an allowance for the esti mated probable losses as
of 6ecember #1, !;;#, for !;;# accounts of P#7; and for !;;$ accounts of P?7;. /t
was also decided to correct the charge against each year so that it shows the losses
Gactual and esti matedH relati ng to that year1s sales. Accounts have been wri tten off
to bad debts e&penses as follows:
In -00. In -001
!;;# accounts P !;; P 1,;;;
!;;$ accounts <;;
#. .'uipment ac'uired by +F4.*F4"O +A%2DA"2*/%: for P#;,;;; on =une
#;, !;;! was sold for P!>,;;; cash on =uly 1, !;;$. he proceeds from the same
were credited to the e'uipment account. he company depreciates e'uipment at
1;E a year. 6epreciation is ta,en up at year0 end computed on a monthl y basis.
6epreciation of P1,>;; was recorded in !;;$.
$. On +ay ;1, !;;!, +F4.*F4"O +A%2DA"2*/%: ac'uired a machine in
e&change for 1,;;; shares of its own P1;; par value common stoc, having a fair
mar,et value of P1!; on this date. he machine was recorded in the accounts at
P1;;,;;;. "ompany policy is to ta,e one half years depreciation on all asset
ac'uisitions or disposals during the year. +achinery is depreciated on a straight
line basis Gno salvage value based on an esti mated life of 1; years.H he company
has recorded depreciation charge of P1,7;; on this machine from ac'uisition to the
end of the current period.
7. +F4.*F4"O +A%2DA"2*/%: purchased a machine on =anuary 1, !;;1 for
P1,7;;,;;;. At the date of ac'uisition, the machine had an esti mated useful life of
> years with no residual value. he machine is being depreciated on a straight0 line
basis. On =anuary 1, !;;$, management determi ned as a result of additional
informat i on, that the machine had an esti mated useful life of < years from the date
of ac'uisition with no residual value.
RE2UIREMENT : =ournal entries
PROBLEM 8
IN9ENTORIES
1. Fou are e&amini ng the financial statements of 6O% =O9% "O*PO*A/O%
which ends on 6ecember #1. 6O% =O9% "O*P. uses the physical
inventory system of accounti ng for inventory. /n the course of your
e&aminati on, you discovered the errors below.
1. :oods received in =anuary !;;7 were recorded as purchase on account
in 6ecember !;;$. he goods were included in the !;;$ ending inventory.
!. he inventory at 6ecember #1, !;;$ is understated as a result of
errors in physical count.
#. :oods received in 6ecember !;;$ were recorded as purchases when
paid in !;;7. he goods were e&cluded from the !;;$ ending inventory.
$. he inventory at 6ecember #1, !;;$ is overstated as a result of the
inclusion of goods ac'uired on consignment.
7. :oods received in =anuary !;;7 were recorded as purchase on account
in 6ecember !;;$. he goods were e&cluded from the !;;$ ending
inventory.
>. :oods received in 6ecember !;;$ were recorded as purchases when
paid in !;;7. he goods were included in the !;;$ ending inventory.
.nter the effect of the errors in the solution guide below. 2se the following
symbols: O0Overstated, 202nderstated J0%o effect
) - . 1 4 5
/ncome 4tatement0 !;;$
Purchases ____ ____ ____ _____ _____ _____
"ost of 4ales ____ ____ ____ _____ _____ _____
%et income ____ ____ ____ _____ _____ _____
5alance 4heet0 6ecember #1, !;;$
/nventory ____ ____ ____ _____ _____ _____
9
Accounts Payable ____ ____ ____ _____ _____ _____
*. before closing ____ ____ ____ _____ _____ _____
*. after closing ____ ____ ____ _____ _____ _____
/ncome 4tatement0 !;;7
Purchases ____ ____ ____ _____ _____ _____
5eginning inventory ____ ____ ____ _____ _____ _____
.nding inventory ____ ____ ____ _____ _____ _____
"ost of 4ales ____ ____ ____ _____ _____ _____
%et income ____ ____ ____ _____ _____ _____
5alance 4heet0 6ecember #1, !;;7
/nventory ____ ____ ____ _____ _____ _____
Accounts Payable ____ ____ ____ _____ _____ _____
*. before closing ____ ____ ____ _____ _____ _____
*. after closing ____ ____ ____ _____ _____ _____

Pro/" e :
/nventory .rrors GPeriodic /nventory 4ystemH
1. !;;# sales were recorded in !;;$I goods were included in the !;;#
ending inventory.
!. !;;$ sales were recorded in !;;#I goods were included in the !;;#
ending inventory.
#. !;;# sales were recorded in !;;$I goods were e&cluded from the !;;#
ending inventory.
$. !;;$ sales were recorded in !;;#I goods were e&cluded from the
!;;# ending inventory.
A B C D
/ncome 4tatement0 !;;#
4ales ____ _____ _____ _____
.nding inventory ____ _____ _____ _____
"ost of 4ales ____ _____ _____ _____
%et income ____ _____ _____ _____
5alance 4heet0 6ecember #1, !;;#
/nventory ____ _____ _____ _____
Accounts PAFA5L. ____ _____ _____ _____
*. before closing ____ _____ _____ _____
*. after closing ____ _____ _____ _____
/ncome 4tatement0 !;;$
4ales ____ _____ _____ _____
5eginning inventory ____ _____ _____ _____
.nding inventory ____ _____ _____ _____
"ost of 4ales ____ _____ _____ _____
%et income ____ _____ _____ _____
5alance 4heet0 6ecember #1, !;;$
/nventory ____ ____ _____ _____
Accounts Payable ____ _____ _____ _____
*. before closing ____ _____ _____ _____
*. after closing ____ _____ _____ _____
Pro/" e )0
Fou have been engaged to prepare the corrected financial statement figures
for 9A44A% /%". he records are in agreement with the followi ng balance sheet:
9assan /nc.
5alance 4heet
6ecember #1, !;;$
1
A44.4 L/A5/L//.4 A%6 "AP/AL
"ash 1@!,7;; Accounts payable 1?7,;;;
Accounts receivable 1@!,7;; %otes payable
7!,7;;
%otes receivable !!?,7;; "ommon stoc,
#7;,;;;
/nventory $#?,7;; *etained earnings $?!,7;;
otal 1,;7;,;;; otal 1,;7;,;;;
A review of the records of the corporati on indicates that the errors and
omissions listed in the table below had not been corrected during the applicable
years.
!;;1 !;;! !;;# !;;$
Overstatement of inventory 0 1!!,7;; 1$;,;;;
0
2nderstatement of inventory 1;7,;;; 0 0
17?,7;;
Prepaid e&pense 17,?7; 1!,!7; <,?7; 1;,7;;
2nearned revenue 0 ?,;;; 0 7,!7;
Accrued e&penses #,7;; 1,#1; 1,?7; <?7
%et income as reported 1#1,!7; 11#,?7;
@>,!7;
%o dividends were declared during the years and no ad)ust ments were made
to retained earnings.
*.K2/*.+.%4:
-or,ing paper to compute for the corrected income for the years !;;!, !;;#
and !;;$.
Prepare a corrected balance sheet for 6ecember #1, !;;$.
MULTIPLE C(OICE PROBLEMS+
1. 4ean "ompanyCs beginni ng inventory at =anuary 1, !;;$ was understated by
P$7,7;;, and its ending inventory was overstated by P@1,;;;. As a result, 4ean
"ompanyC s cost of goods sold for !;;$ was:
a. 2nderstated by P$7,7;;
b. Overstated by P$7,7;;
c. 2nderstated by P1#>,7;;
d. Overstated by P1#>,7;;
!. On =anuary 1, !;;!, 5reton "ompany purchased for P$!;,;;; a machine with
a useful life of 1; years and no salvage value. he machine was depreciated by the
double declining balance method and the carrying amount of the machine was
P!><,<;; on 6ecember #1, !;;#. 5reton "ompany changed to the straight line
method on =anuary ;1, !;;$. -hat would be the depreciation e&pense on this
machine for the year ended 6ecember #1, !;;$8
a. P !>,<<;
b. P ##,>;;
c. P $!,;;;
d. P 7#,?>;
#. 5randy "orp. reports on a calendar0 year basis. /ts !;;$ and !;;7 financial
statements contained the following errors:
!;;$ !;;7
Over GunderH statement of ending inventory P1;,;;; P $,;;;
2nderstatement of depreciati on $,;;; >,;;;
Dailure to accrue salaries at year end <,;;; 1!,;;;
1
As a result of the above errors, !;;7 income would be:
a. overstated by P$,;;;
b. overstated by P!$,;;;
c. overstated by P!!,;;;
d. overstated by P1>,;;;
$. On =anuary ;1, !;;1, Laden "ompany purchased a patent for P7#7,7;;. he
patent is being amorti3ed over its remaini ng life of 17 years e&piring =anuary ;1,
!;1>. 6uring !;;$, Laden "ompany determi ned that the economic benefits of the
patent would not last longer than 1; years from the date of ac'uisition. -hat
amount should be reported in the 5alance sheet for the patent, net of accumulated
amorti3ati on on 6ecember #1, !;;$8
a. P #!1,#;;
b. P #>?,!;;
c. P #?<,;;;
d. P #@!,?;;
7. .ffective =anuary !, !;;7, Aincaid "o. adopted the accounti ng principle of
e&pensing advertising and promoti on costs as they are incurred. Previousl y,
advertising and promoti on costs applicable to future periods were recorded in
prepaid e&penses. Aincaid can )ustify the change, which was made for both financial
statement and income ta& reporti ng purposes. Aincaid1s prepaid advertising and
promotion costs totaled P!7;,;;; at 6ecember #1, !;;$. Assume that the income
ta& rate is $; percent for !;;$ and !;;7. he ad)ust ment for the effect of the
change in accounti ng principle should result in a net charge against income in the
income statement for !;;7 of
a. P ;
b. P 1;;,;;;
c. P 17;,;;;
d. P !7;,;;;
>. On =anuary ;1, !;;1, *odney "ompany purchased a machine for P#@>,;;;
and depreciated it using the straight line method using an esti mated useful life of <
years with no salvage value. On =anuary 1, !;;$, *odney "ompany determi ned
that the machine had a useful life of si& years from the date of ac'uisition and will
have a salvage value of P#>,;;;. An accounting change was made in !;;1 to
reflect this additional data. he accumulated depreciati on for this machine should
have a balance at 6ecember #1, !;;$ of:
a. P !1@,;;;
b. P !#1,;;;
c. P !$;,;;;
d. P !>$,;;;
?. 5art, /nc. receives subscription payments for annual Gone yearH subscriptions to
its
maga3ine. Payments are recorded as revenue when received. Amounts received but
unearned
at the end of each of the last three years are shown below:
!;;# !;;$
!;;7
2nearned revenues P1!;,;;; P17;,;;;
P1?>,;;;
5art failed to record the unearned revenues in each of the three years. As a result
of the omission, !;;7 income was:
a. overstated by P1$>,;;;
b. understated by P1$>,;;;
c. understated by P!>,;;;
d. overstated by P!>,;;;
<. :lobe "orporation offers a # year warrant y for its products. /t previously
esti mated warrant y costs to be !E of sales. 6ue to technological advance in
production at the beginning of !;;$, :lobe "orporation now believes 1E of sales to
be a better esti mate of warrant y costs. -arranty cost of P1$;,;;; and P1><,;;;
1
were reported in !;;! and !;;# respecti vel y. 4ales for !;;$ was P<,?7;,;;;. 9ow
much should be reported in !;;$ as warrant y e&pense.
a. P <?,7;;
b. P 17$,;;;
c. P 1?7,;;;
d. P !$1,7;;
@. An insurance premi um of P#,>;; was prepaid in !;;$ covering the years
!;;$, !;;7, and !;;>. he entire amount was charged to e&pense in !;;$. /n
addition, on 6ecember #1, !;;7, fully depreciated machinery was sold for P>,$;;
cash, but the sale was not recorded until !;;>. here were no other errors during
!;;$ or !;;7, and no corrections have been made for any of the errors. /gnore
income ta& considerations. -hat is the total effect of the errors on !;;7 net
income8
a. %et income is understated by P1!,<;;
b. %et income is overstated by P#,>;;
c. %et income is understated by P1,>;;
d. %et income is overstated by P!,$;;
1;. Adger "orporation purchased a machine for P17;,;;; on =anuary 1, !;;$.
Adger will depreciate the machine using the straight0 line method using a five0 year
period with no residual value. As a result of an error in its purchasing records,
5adger did not recogni3e any depreciati on for the machine in its !;;$ financial
statements. Adger discovered the problem during the preparation of its !;;7
financial statements. -hat amount should Adger record for depreciation e&pense
on this machine for !;;78
a. P ;
b. P #;,;;;
c. P #?,7;;
d. P >;,;;;
11. On =anuary 1, !;;!, :ray "ompany purchased for P!$;,;;; a machine with a
useful life of ten years and no salvage value. he machine was depreciated by the
double0 declining0 balance method, and the carrying amount of the machine was
P17#,>;; on 6ecember #1, !;;#. :ray changed retroacti vel y to the straight0 line
method on =anuary 1, !;;$. :ray can )ustify the change. -hat should be the
depreciation e&pense on this machine for the year ended 6ecember #1, !;;78
a. P 17,#>;
b. P 1@,!;;
c. P !$,;;;
d. P #;,?!;
1!. Lain "ompany reported net income of P#?7,;;; in !;;$. Four audit
disclosed the followi ng errors:
/ncome received in advance in !;;$ of P1<,?7; was credited to a revenue
account when received. Of the total P#,?7; was earned in !;;$, P@,;;; will be
earned in !;;7 and the remainder in !;;>. P11,!7; loss on sale of e'uipment in
!;;$ was erroneousl y debited to retained earnings.
-hat is the correct net income for !;;$8
a. P #$<,?7;
b. P #>#,?7;
c. P #>@,?7;
d. P #$7,;;;
1#. =erry "ompany reported a net income of P7!7,;;; in !;;$. Four audit
disclosed the followi ng:
!;;$ !;;7
Overstatement of ending inventory !1,?7;
!$,?7;
Omission of depreciation 11,!7; 11,!7;
2nderstatement of commission receivable 1>,7;;
1#,7;;
Purchase of mdse not recorded but included in
the year end inventory $7,;;;
Ad)usted net income for !;;$ is:
a. P 7!7,;;;
1
b. P 7;?,?7;
c. P 7#1,;;;
d. P 77!,?7;
1$. Aentuc,y .nterprises purchased a machine on =anuary !, !;;$, at a cost of
P1!;,;;;. An additional L7;,;;; was spent for installation, but this amount was
charged erroneously to repairs e&pense. he machine has a useful life of five years
and a salvage value of P!;,;;;. As a result of the error,
a. *etained earnings at 6ecember #1, !;;7 was understated by P#;,;;;
and
!;;7 income was overstated by P>,;;;.
b. *etained earnings at 6ecember #1, !;;7 was understated by P#<,;;;
and
!;;7 income was overstated by P>,;;;.
c. *etained earnings at 6ecember #1, !;;7 was understated by P#;,;;;
and
!;;7 income was overstated by P1;,;;;.
d. !;;$ income was understated by P7;,;;;.
17. On 6ecember #;, !;;$, 4augie "orporation sold merchandise for P7>,!7; to
4teve
"ompany. he terms of the sale were net #; days, 6O5 4hipping point. he
merchandise was shipped on 6ecember #1, !;;$ and arrived at 4teve "ompany on
M=anuary ;7, !;;7. 6ue to clerical error, the sale was not recorded until =anuary
!;;7 and the merchandise, s,id at a !7E mar,up on cost was included in 4augieCs
inventory at 6ecember #1, !;;$. As a result, 4augieCs cost of goods sold for the
year ended 6ecember #1, !;;$ was:
2nderstated by P7>,!7;
2nderstated by P$7,;;;
2nderstated by P11,!7;
"orrectl y stated
/tems 1> and 1? are based on the followi ng informat i on:
Fou were engaged as an independent auditor of homas "orporation . /n
the course of your e&aminati on of the accounts on 6ecember #1, !;;$, the end of
the accounti ng period, you determi ned that certain prepaid and accrued items were
not recorded in prior years and in the current year as follows:
!;;! !;;# !;;$
Accrued e&penses $,7;; ?,7;; >,7;;
Prepaid e&penses 7,;;; 1!,;;; <,;;;
Prepaid revenues 1,!;; !,?7;
*evenues receivable #,;;; !,7;;
*etained earnings at the end of !;;! amounted to P$$7,;;; while net
income for !;;# was reported at P1!>,;;;. he income summary account for !;;$
shows a credi t balance of P17;,;;; before any audit ad)ust ments. Fou have
verified that no dividends were declared in the two year period.
1>. "ompute for the corrected *etained earnings balance as of 6ecember #1,
!;;!.
a. P $$$,#;;
b. P $7;,;;;
c. P 7?<,7;;
d. P $$7,;;;
1?. he corrected net income for the years ended 6ecember #1, !;;# and !;;$
are:
!;;# !;;$
a. P1!>,;;; P17;,;;;
b. P1#$,!;; P1$#,?7;
c. P1$>,?;; P1><,;;;
d. P1!!,!;; P177,?7;
1<. On =anuary 1, !;;!, "arnival 4hipping bought a machine for P1,7;;,;;;. At
that time, this machine had an esti mated useful life of si& years, with no salvage
value. As a result of additional informat i on, "arnival determi ned on =anuary 1, !;;7,
that the machine had an esti mated useful life of eight years from the date it was
ac'uired, with no salvage value. Accordingl y, the appropriate accounti ng change
1
was made in !;;7. 9ow much depreciation e&pense for this machine should
"arnival record for the year ended 6ecember #1, !;;7 assuming "arnival uses the
straight0 line method of depreciati on8
a. P 1!7,;;;
b. P 17;,;;;
c. P 1<?,7;;
d. P !7;,;;;
1@. "ombs, /nc. is a calendar0 year corporation whose financial statements for
!;;$ and !;;7 included errors as follows:
.nding /nventory 6epreciation .&pense
!;;$ P#;,;;; overstated P!7,;;; overstated
!;;7 P1;,;;; understated P <,;;; understated
Assume that purchases were recorded correctl y and that no correcti ng entries were
made at 6ecember #1, !;;$, or 6ecember #1, !;;7. /gnoring income ta&es, by how
much should "oombs1 retained earnings be retroacti vel y ad)usted at =anuary 1,
!;;>8
a. P !?,;;; increase
b. P !?,;;; decrease
c. P ?,;;; decrease
d. P #,;;; decrease
!;. Aoppell "o. made the following errors in counting its year0 end physical
inventori es:
!;;# P >;,;;; overstatement
!;;$ 1;<,;;; understatement
!;;7 @;,;;; overstatement
As a result of the above undetected errors, !;;7 income was
a. 2nderstated by P1<,;;;
b. Overstated by P1@<,;;;
c. Overstated by P1<,;;;
d. 2nderstated by P1@<,;;;
!1. Aoppell "o. made the following errors in counting its year0 end physical
inventori es:
!;;# P >;,;;; overstatement
!;;$ 1;<,;;; understatement
!;;7 @;,;;; overstatement
he entry to correct the accounts at the end of !;;7 is
a. *etained earnings $<,;;;
"ost of sales $!,;;;
/nventory @;,;;;
b. *etained earnings 1<,;;;
"ost of sales ?!,;;;
/nventory @;,;;;
c. /nventory @;,;;;
"ost of sales 1<,;;;
*etained earnings ?!,;;;
d. "ost of sales 1@<,;;;
*etained earnings 1;<,;;;
/nventory @;,;;;
!!. /n the course of your e&aminati on of the financial statements of "orrea
"orp., a new client, for the year ended 6ecember #1, !;;$, you discovered the
following:
a. /nventory at =anuary ;1, !;;$ had been overstated by P##,?7;.
b. /nventory at 6ecember #1, !;;$ was understated by P7>,!7;.
c. An insurance policy covering three years had been purchased on
=anuary ;1,
!;;# for P!!,7;;. he whole amount was charged to e&pense in !;;#.
1
d. 6uring !;;$, the company received a P17,;;; cash advance from a
customer for goods to be manufactured and shipped during !;;7. he
amount received was credi ted to sales.
/ncome reported for !;;$ before reflecting any ad)ust ment for the above
informat i on is P1<?,7;;. he correct income for !;;$ is:
a. P !77,;;;
b. P !!1,!7;
c. P 1>7,;;;
d. P 17;,;;;
!#. om "ompanyCs beginni ng inventory at =anuary ;1, !;;$ was understated by
P$7,7;; and its ending inventory was overstated by P@1,;;;. As a result, om
"ompanyC s cost of goods sold for !;;$ was:
a. 2nderstated by P$7,7;;
b. Overstated by P$7,7;;
c. 2nderstated by P1#>,7;;
d. Overstated by P1#>,7;;
!$. he net income for !;;$ reported by the accountant of Abbas "ompany
amounted to P>#$,7;;. Four audit of the accounts disclosed that the following
accounts were not recorded:
!;;# !;;$
*ent received in advance !!,7;; #;,;;;
Accrued salaries 1#,7;; 1<,;;;
Prepaid interest ##,?7; $7,;;;
"ommission receivable 17,?7; 1$,>!7
6epreciation e&pense !>,!7;
!>,!7;
.'uipment purchased at year end charged
to e&pense G1; year lifeH ?7,;;;
"ompute the correct income for the year ended 6ecember #1, !;;$.
a. P 7@<,<?7
b. P >1#,<?7
c. P >77,1!7
d. P ><1,#?7
!7. he first e&aminati on of amerCs financial statements was made for the year
ended 6ecember #1, !;;$. he auditor has found that amer had purchased
another company in =anuary !;;! and recorded goodwi ll of P?7,;;; in connection
with this purchase. /t was determi ned that the goodwil l had an esti mated useful life
of only five years because of obsolescence. %o amorti3ati on of goodwill had ever
been recorded.
Dor the 6ecember #1, !;;$ financial statements, amer should debit
amorti3ati on e&pense of:
Amorti3ati on e&penses *etained earnings
a. P ; P?7,;;;
b. P17,;;; P#;,;;;
c. P!7,;;; P ;
d. P$7,;;; P ;
END
1