Professional Documents
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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.
.&les 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