chapter19 - comprehensive audit of balance sheet and income statement accounts

7/30/2019 Chapter19 - Comprehensive Audit of Balance Sheet and Income Statement Accounts

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19

CHAPTERCOMPREHENSIVE AUDIT OF

BALANCE SHEET AND INCOME

STATEMENT ACCOUNTS

19-1. Daffodil, Inc.

Adjusting Journal Entries

12.31.07

AJE (1) Share donation 60,000Treasury shares 35,000Land 10,000

Building 15,000

(2) Accumulated depreciation - machinery 1,000

Loss on sale of machinery 2,000

Machinery 3,000

Cost P 5,000

Less: AD (20%) 1,000

NBV P 4,000

Proceeds 2,000

Loss P 2,000

(3) (a) Accumulated depreciation - building 300

Retained earnings 300

(b) Factory operating expenses 21,300

Accumulated depreciation - building 6,300

Accumulated depreciation - machinery 15,000

Building (P315,000 x 2%)

Machinery:

5,000 x 10% = P 500145,000 x 10% = 14,500

P15,000

(4) Merchandise inventory, 12.31.07 B/S 175,000

Merchandise inventory, 12.31.07 I/S 175,000


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19-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition

(5) Administrative expenses 1,000

Allowance for doubtful accounts 1,000

(6) Factory operating expenses 3,000

Unexpired insurance 3,000

(7) Retained earnings 2,500

Bond interest expense 2,500Unamortized bond discount 5,000

(8) Sinking fund assets 23,500

First Mortgage SF Bonds 23,500

(9) Sinking fund assets 1,500

Sinking fund income 1,500


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Comprehensive Audit of Balance Sheet and Income State

19-1. Daffodil, Inc. (continued)Daffodil, Inc.

Working Trial Balance12.31.07

Trial Balance Adjustments Income Statement

Dr Cr Dr Cr Dr Cr Cash P 64,000

Accounts receivable 200,000 Provision for doubtful accounts P 1,000 (5) 1,000 Inventories, 12.31.06 223,000 P 223,000Unexpired insurance, 12.31.06 6,000 (6) 3,000 Land 220,000 (1) 10,000 Buildings 330,000 (1) 15,000

Accumulated Depreciation - Buildings 6,600 (3a) 300 (3b) 6,300 Machinery 148,000 (2) 3,000

Accumulated Depreciation - Machinery 15,000 (2) 1,000 (3b) 15,000 Sinking fund assets 25,000 (8) 23,500

(9) 1,500 Unamortized bond discount 25,000 (7) 5,000 Treasury shares, ordinary 35,000 (1) 35,000

Accounts payable 88,000

Bond interest accrued 3,750 1st Mortgage, 6% SF Bonds 226,500 (8) 23,500 Ordinary shares 500,000 Premium on ordinary shares 50,000 Share donation 60,000 (1) 60,000 Retained earnings, 12.31.06 74,150 (7) 2,500 (3a) 300 Sales 875,000 P 875,000Purchases 283,500 283,500Payroll 169,000 169,000Factory operating expenses 121,500 (3b) 21,300

(6) 3,000 145,800Administrative expenses 35,000 (5) 1,000 36,000

Bond interest expense 15,000 (7) 2,500 17,500P1,900,000 P1,900,000

Loss on sale of machinery (2) 2,000 2,000Merchandise inventory 12.31.07 (4) 175,000 (4) 175,000 175,000

Sinking fund income (9) 1,500 1,500

P 293,600 P 293,600 P 876,800 P1,051,500 Net Income 174,700

P1,051,500 P1,051,500


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19-2.

Part I Adjusting Journal Entries, 12-31-05

AJE (1) Depreciation expense 1,778

Accumulated depreciation 1,778

(2) Prepaid interest 5,000

Retained earnings 3,100

Interest expense 1,900

(3) Merchandise inventory, 12-31-07, BS 15,000

Merchandise inventory, 12-31-07, IS or

Cost of Sales

15,000

(4) Retained Earnings 6,000

Purchases 6,000

(5) Prepaid insurance 3,000

Insurance expense 3,000

(6) Store supplies inventory 1,450Store supplies expense 550

Retained earnings 900

(7) Retained earnings 730Commissions expense 240

Accrued commissions payable 970

(8) Cash in bank 650

Miscellaneous income 650

(9) Purchases 800

Accounts payable 800

(10) Income from Investment 3,000

Investment 3,000

(11) Prepaid advertising and promotions 90,000

Advertising and promotions expense 90,000

(12) NO AJE

(13) Machinery 20,000

Depreciation expense machinery 167

Allowance for depreciation machinery 167

Repairs and maintenance 20,000

[(P22,000 P2,000) P4,000]

9


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Comprehensive Audit of Balance Sheet and Income Statement Accounts 19-5

(14) Miscellaneous income 2,000

Gain on sale of treasury shares 5,000Land 2,000

Additional paid-in capital arising from

Treasury Share transactions 5,000

(15) Doubtful accounts expense 14,500

Allowance for uncollectible accounts 14,500

Required allowance as of 12-31-07 on past due accounts (5% x P30,000)

on current accounts (1% x P400,000)

Total

Unadjusted debit balance of the Allowanceaccount

Additional Provision

P 1,5004,000

P 5,500

9,000

P14,500

Part II Column B Adjustment, 12-31-07

AJE (a) Retained earnings xx

Purchases xx

(b) NONE xx

xx

(c) Retained Earnings xx

Allowance for depreciation xx

(d) Retained Earnings xx

Allowance for depreciation xx

(e) Machinery xx

Retained earnings xx

(f) Depreciation xxAllowance for depreciation xx

(g) Retained earnings xxTaxes xx

19-3. International Company

AJE (1) Depreciation expense 3,200Accumulated depreciation delivery vehicle 3,200

(2) Cost of sales 19,000



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Inventory 8,500

(4) Cash 5,600

Accounts receivable 5,600

(5) Accumulated depreciation equipment 22,000

Equipment 18,300Gain on sale of equipment 3,700

(6) Estimated litigation loss 125,000

Estimated litigation liability 125,000

(7) Unrealized holding gain or loss Income 2,000

Allowance for decline in value of securities 2,000

(8) Accrued salaries payable 3,800

Salaries expense 3,800

(9) Depreciation expense 4,000

Equipment 32,000

Repairs expense 32,000Accumulated depreciation equipment 4,000

(10) Insurance expense 5,000Prepaid insurance 7,000


(11) No adjusting entry. Trademark has indefinitelife and no amortization need be made.

19-4. Sunshine Cosmetics, Inc.

Requirement (1)

AJE (1) Inventory, Dec. 31, 2006 (BS) 67,200

Inventory, Dec. 31, 2006 (IS) or

Cost of sales 67,200

(2) Doubtful accounts expense 14,920

Allowance for doubtful accounts

(15,660 740) 14,920

(3) Accounts payable 20,760

Purchase returns and allowances 20,760


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(4) Sales commissions 216

Accrued commissions payable 216

(5) Freight-in 1,600


(6) Advertising expense 1,212

Prepaid advertising 1,212

(7) Freight-out or Expense 8,400

Sales 8,400

(8) Interest receivable 1,380Interest income 1,380

(9) Depreciation expense 1,300Accumulated depreciation 1,300

(10) Supplies expense 1,160

Unused Supplies 1,160

(11) Provision for Income tax expense 107,386

Income tax payable 107,386

Requirement (2)

Sunshine Cosmetics, Inc.

Income StatementFor the Year Ended December 31, 2006

Revenue from sales:

Sales P998,800 (a)

Less: Sales returns and

and allowances P 22,400Sales discounts 1,760 24,160 P974,640

Cost of goods sold:

Inventory, January 1 P179,400

Net purchases:

Purchases P346,000Less purchase returns

and allowances 20,760 (c)

325,240

Freight-in 12,650 (b)Cost of goods available

for sale P517,290Less Inventory, December 31 108,300 (d) 408,990

Gross profit on sales P565,650


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Other income:

Interest revenue P 2,780 (i)Dividend revenue 14,300

Gain on sale of assets 37,000 54,080

Total income P619,730Operating expenses:

Selling expenses:

Sales salaries andcommissions P 70,216 (e)

Advertising expense 33,392 (f)

Depreciation expense

Sales/delivery equipment

13,500 (g)

Freight expense 8,400Travel expense sales

representatives 9,120

Miscellaneous sellingexpenses 4,400 P139,028

General and administrative

expenses:Legal services P 4,450

Insurance and licenses 17,000

Depreciation expense

office equipment 9,600Utilities 12,800

Telephone and postage 2,950

Supplies expense 1,160 (k)

Officers salaries 73,200

Doubtful accounts expense 14,920 (h) 136,080

Total operating expenses (275,108)Other expense and losses:

Interest expense P 9,040Loss on sale of equipment 45,200 (54,240)

Income from continuing

operations before income taxes

P290,382

Income taxes 92,922 (j)

Income from continuingoperations P197,460

Discontinued operations:

Gain from discontinuedoperations (net of income

taxes of P25,600) 54,400

Net income P251,860


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Earnings per ordinary share:

Income from continuing operations (P197,460 78,000 shares) P2.53Gain from discontinued operations (P54,400 78,000 shares) 0.70

Net income (P251,860 78,000 shares) P3.23

Computations:

(a) Sales: P990,400 + P8,400 = P998,800

(b) Freight-in: P11,050 + P1,600 = P12,650

(c) Purchase returns and allowances: P346,000 x 6% = P20,760

(d) Inventory: P41,100 + P67,200 = P108,300

(e) Sales salaries and commissions: P70,000 + (P7,200 x 3%) = P70,216(f) Advertising expense: P32,180 + (P3,636 x 2/6) = P33,392

(g) Depreciation expense: P12,200 + (P15,600 x 10/120) = P13,500

(h) Doubtful accounts expense: (P522,000 x 3%) P740 = P14,920(i) Interest revenue: P1,400 + P1,380 = P2,780

(j) Income taxes: P335,582 x 32% = P107,387

(k) Supplies expense: P4,360 P3,200 = P1,160

Sunshine Cosmetics, Inc.Retained Earnings Statement

For the Year Ended December 31, 2006

Retained earnings, January 1 P 881,340Add net income per income statement 251,860

P1,133,200

Deduct dividends paid 66,000Retained earnings, December 31 P1,067,200

19-5. Del Bakery

Working papers are not required, but they facilitate the preparation of a corrected

balance sheet.

Del BakeryWorking Papers for Corrected Balance Sheet

December 31, 2007

Balance Sheet Corrections Corrected Balance Sheet

Account Title Debit Credit Debit Credit Debit Credit

Current Assets..................... 53,415 .............. .............. (a) 53,415 ............. ..............Current Liabilities ................. ............. 29,000 (c) 29,000 ............. ............. ..............Other Assets........................ 75,120 .............. .............. (b) 75,120 ............. ..............Other Liabilities .................... ............. 3,600 (d) 3,600 ............. ............. ..............Investment in Business........ ............. 95,935 (e) 95,935 ............. ............. ..............

128,535 128,535 .............. ............. ............. ..............


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Cash..................................... ............. .............. (a) 10,600 ............. 10,600 ..............Investment Securities trading (at market value).... ............. .............. (a) 2,575 ............. 2,575 ..............

Trade Accounts Receivable. ............. .............. (a) 12,500 ............. 12,500 ..............Inventory............................... ............. .............. (a) 8,040 ............. 8,040 ..............Supplies Inventory................ ............. .............. (a) 425 ............. 425 ..............Delivery Truck...................... ............. .............. (a) 2,100 ............. 2,100 ..............Fixtures................................. ............. .............. (a) 12,500 ............. 12,500 ..............

Accumulated Depreciation Fixtures............................... ............. .............. .............. (a) 2,100 ............. 2,100

Cash Surrender Value ofInsurance on OfficersLives................................... ............. .............. (a) 4,100 ............. 4,100 ..............

Retained Earnings................ ............. .............. (a) 2,675 ............. ............. ........................... .............. (b) 7,750 ............. ............. ........................... .............. (d) 350 ............. ............. 30,160............. .............. .............. (e) 40,935 ............. ..............

Land..................................... ............. .............. (b) 30,000 ............. 30,000 ..............

Buildings............................... ............. .............. (b) 62,000 ............. 62,000 ..............Accumulated Depreciation

Buildings [2(P62,000 20)] ............. .............. .............. (b) 7,750 ............. 7,750

11% Mortgage Payable........ ............. .............. .............. (b) 12,000 ............. 12,00011% Mortgage Payable(current portion).................. ............. .............. .............. (b) 4,000 ............. 4,000

Interest Payable................... ............. .............. .............. (b) 880 ............. 880Trade Accounts Payable...... ............. .............. .............. (c) 29,000 ............. 29,000Miscellaneous Liabilities ...... ............. .............. .............. (d) 3,950 ............. 3,950Share Capital, P5 statedvalue, 5,000 shares............ ............. .............. .............. (e) 25,000 ............. 25,000

Paid-in Capital from Sale ofShares at More ThanStated Value....................... ............. .............. .............. (e) 30,000 ............. 30,000

284,150 284,150 144,840 144,840

Corrections: (a) To restate current assets (d) To restate other liabilities(b) To restate other assets (e) To restate owners equity accounts(c) To restate current liabilities

Del Bakery

Corrected Balance Sheet

December 31, 2007

Assets

Current assets:

Cash ........................................................................ P10,600

Investment securities trading (reported atmarket; cost P4,250) ......................................... 2,575

Trade accounts receivable (fully collectible).......... 12,500

Inventory................................................................. 8,040Supplies inventory.................................................. 425 P 34,140


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Investments:

Cash surrender value of life insurance.................... 4,100Land, buildings and equipment:

Land........................................................................ P30,000

Buildings.................................................. P62,000Less accumulated depreciation .......... 7,750 54,250

Fixtures.................................................... P12,500

Less accumulated depreciation .......... 2,100 10,400Delivery truck......................................................... 2,100 96,750

Total assets................................................................... P134,990

Liabilities

Current liabilities:Mortgage payable, portion due this year ................ P 4,000

Accounts payable.................................................... 29,000

Interest payable....................................................... 880Miscellaneous accrued liabilities............................ 3,950 P 37,830

11% Mortgage payable (noncurrent portion) ............... 12,000

Total liabilities.............................................................. P 49,830

Owners Equity

Contributed capital:

Share capital, P5 stated value,

5,000 shares ....................................... P25,000Paid-in capital from sale of

ordinary shares at more than

stated value ........................................ 30,000 P55,000

Retained earnings ......................................................... 30,160

Total owners equity..................................................... 85,160Total liabilities and owners equity .............................. P134,990

19-6. Masipag Corporation

Adjusting Journal Entries, Dec. 31, 2007

AJE (1) Cash 200,000Accounts payable 200,000

(2) Accounts receivable 10,000Cash 10,000

(3) Bank loan payable 400,000Other expenses 12,500

Cash 412,500


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(4) Cash 75,000


(5) Operating expenses 1,500Cash 1,500

(6) Cash 16,000

Other income 16,000

(7) Accounts receivable others (2,000 + 3,000) 5,000

Operating expenses 2,000

Cash 7,000

(8) Marketable securities 40,000

Other income 40,000

(9) Other income 54,000Marketable securities 54,000

(10) Marketable securities 32,000Other income 32,000

(10.a) Valuation allowance Marketable securities

Trading 145,600Other income Unrealized holding gain 145,600

(11) Sales 500,000


(12) Inventory 400,000


(13) Accounts receivable others (30,000 15,000) 15,000


(14) Accounts receivable others 55,000


(15) Accounts receivable 50,000

Other current liabilities 50,000

(16) Operating expenses 21,900

Allowance for doubtful accounts 21,900

(17) Other income 54,545

Discount on notes receivable 54,545

(18) Discount on notes receivable 4,545Other income 4,545


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Inventory 16,000

(23) Sales 13,000Accounts receivable 13,000

(24) Operating expenses 46,250Prepaid expenses 46,250


Prepaid expenses 5,000

(26) Other assets 60,000Operating expense 120,000

Prepaid expenses 180,000

(27) Long-term bond investment 5,777

Other income 5,777

(28) Accounts receivable others 5,333Other income 5,333

(29) Land 1,062,500

Building 3,187,500Land and building 4,250,000

(30) Building 425,000Land and building 425,000

(31) Operating expenses 20,000Land and building 20,000

(32) Operating expenses 27,500Prepaid expenses 27,500

Land and building 55,000


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(33) Land and building 237,500

Operating expenses 115,578Accumulated depreciation building 121,922

(34) Prepaid expenses 10,000Operating expenses 10,000

Equipment 20,000


Accumulated depreciation equipment 55,400

(36) Accounts payable 50,000

Other current liabilities 50,000


Estimated liability on warranties 15,000

(38) Other current liabilities 50,000

Other expenses 50,000

(39) Income taxes payable 115,290

Provision for income tax 115,290

MASIPAG CORPORATION

Balance SheetDecember 31, 2007

Assets

Current assetsCash P 734,000Marketable securities P 400,000

Valuation allowance 145,600 545,600

Accounts receivable P 442,000Allowance for doubtful accounts (33,150) 408,850

Notes receivable P 600,000

Discount on notes receivable (50,000) 550,000Accounts receivable others 96,333Inventory, December 31, 2007 1,960,500Prepaid expenses 175,250

Total current assets P4,470,533Investments

Long-term bond investment 744,077

Property, plant and equipmentLand P1,062,500Building P3,612,500Accumulated depreciation Building (121,922) 3,490,578


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Equipment P1,654,000

Accumulated depreciation Equipment (235,400) 1,418,600

Total property, plant and equipment 5,971,678Other assets 110,000

Total assets P11,296,288

Liabilities and Shareholders Equity

Current liabilitiesAccounts payable P 877,000Bank loan payable 1,100,000Accrued expenses payable 59,000

Other current liabilities 100,000Income taxes payable 130,558Estimated liability on warranties 70,000

Total current liabilities P 2,336,558

Shareholders equity

Ordinary shares P5,000,000Additional paid-in capital 1,655,250Retained Earnings 2,304,480Total shareholders equity 8,959,730

Total liabilities and shareholders equity P11,296,288

MASIPAG CORPORATIONIncome Statement


Sales P 6,437,000

Cost of sales (4,060,000)Gross profit P 2,377,000Other income 225,710Operating expenses (1,511,509)

Other expenses (37,500)Income before taxes P 1,053,701Provision for income tax (342,441)

Net Income P 711,260

19-7. Felicity Company

Adjusting Journal Entries, Dec. 31, 2007

AJE (1) Cash 31,000

Prepaid interest 3,000Other charges 2,000

Long-term debt (current portion) 24,000

Long-term debt 12,000


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(2) Cash 2,000

Accounts payable and others 2,000

(3) Investments in SMC shares available for sale

(non-current) 72,000Marketable securities 72,000

(4) Unrealized loss due to decline in value ofnon-current investment (equity) 20,000


(5) Allowance for doubtful accounts 41,100


(6) Accounts receivable 8,000




(8) Sales 14,400Accounts receivable 14,400

(9) Revaluation increment 120,000

Accumulated depreciation 80,000Property and equipment 200,000

(10) Accumulated depreciation 36,000



Accumulated depreciation 48,000

(12) Revaluation increment 24,000


(13) Property and equipment 30,000


(14) Retained earnings 13,000

Cumulative effect of change in accounting

principle

13,000


Cash 22,000


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(16) Provision for income tax 25,445

Income tax payable 25,445

FELICITY COMPANY

Balance SheetDecember 31, 2007

Assets

Current Assets:

Cash............................................................................................ P 123,600

Accounts receivable ................................................................... 1,751,820

Allowance for doubtful accounts ............................................... (27,000)Accounts receivable -others ....................................................... 62,000

Inventories.................................................................................. 262,000

Prepaid interest........................................................................... 3,000

Non-current Assets:

Advances to affiliate .................................................................. 48,000Investments in SMC shares available for sale......................... 72,000

Allowance for decline in value of non-current investment ........ (20,000)

Property and equipment ............................................................. 2,600,000

Accumulated depreciation.......................................................... (1,172,000)

Total Assets P 3,703,420

Liabilities and Shareholders Equity

Accounts payable and others (including current portion of

bank loan of P24,000) ............................................................... P 434,616Income tax payable............................................................................ 100,205

Long-term debt.................................................................................. 72,000

Ordinary share capital ....................................................................... 2,042,000

Retained earnings .............................................................................. 978,599

Unrealized loss due to decline in value of investment in SMC......... (20,000)Revaluation increment....................................................................... 96,000

Total Liabilities and Shareholders Equity P 3,703,420

FELICITY COMPANY

Income Statement


Sales .................................................................................................. P 2,757,124

Cost of sales ...................................................................................... 2,257,604

Gross profit........................................................................................ P 499,520

Operating expenses ........................................................................... (83,522)Other charges..................................................................................... (102,000)


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Income from continuing operations before tax.................................. P 313,998

Provision for income tax (35%) ........................................................ 109,899Income from continuing operations after tax .................................... P 204,099

Discontinued operations (net) ........................................................... (6,500)

Net income ........................................................................................ P 197,599

19-8. Learn Company

Condensed Comparative Income Statements

2009 2008 2007

Construction revenue P900,000 P420,000 P200,000

Construction expense (420,000) (182,000) (80,000)

Other expenses (80,000) (70,000) (50,000)

Income before income taxes P400,000 P168,000 P 70,000

Income tax expense (120,000) (50,400) (21,000)

Net income P280,000 P117,600 P 49,000

Comparative Statements of Retained Earnings

2009 2008 2007

Balance at beginning of year,

as previously reported P 77,000 P 7,000 P 0

Add: Adjustment for the

cumulative effect on prior years

of applying retroactively thenew method of accounting forlong-term contracts (net of

income taxes) 89,600 b 42,000 a 0


as adjusted P166,600 P 49,000 P 0

Net income 280,000 117,600 49,000

Balance at end of year P446,600 P166,600 P 49,000

Note: The company has accounted for revenue and costs for long-termconstruction contracts by the percentage-of-completion method in 2009, whereas

in prior years revenues and costs were determined by the completed-contractmethod. The new method of accounting for long-term contracts was adopted to

(state justification for change in accounting principle) and financial statements ofprior years have been restated to apply the new method retroactively. The effect


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of the accounting change on income of 2009 and on income as previously reported

in 2007 and 2008 is as follows:

Increase

2009 2008 2007

Net income P112,000 c P47,600 P42,000

Earnings per ordinary share P11.20 P4.76 P4.20

The balances of retained earnings for 2008 and 2009 have been adjusted for the

after-tax effect of applying the new method of accounting retroactively.

a P49,000 P7,000b (P49,000 + P117,600) (P7,000 + P70,000)c P280,000 [(P600,000 P280,000 P80,000) x (1 0.30)]

19-9. Goody Construction Company

Requirement (1)

2007Jan. 1 Construction in Progress 70,000 a

Retained Earnings [P70,000 x (1 0.30)] 49,000

Deferred Tax Asset 21,000a [(P100,000 + P120,000) + (P125,000 +

P75,000)] (P100,000 + P250,000)

Requirement (2)

GOODY CONSTRUCTION COMPANY

Condensed Comparative Income Statements (Partial)

2007 2006 2005

Income before income taxes P400,000 P200,000 P220,000

Income taxes at 30% (120,000) (60,000) (66,000)

Net income P280,000 P140,000 P154,000

Earnings per ordinary share

(100,000 shares) P2.80 P1.40 P1.54


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Comparative Statements of Retained Earnings

2007 2006 2005


as previously reported P245,000 c P 70,000 b P 0Add: Adjustment for the

cumulative effect on prior years

of applying retroactivelyapplying the new method of

accounting for long-term

contracts (net of income taxes) 49,000 e 84,000 d 0


as adjusted P294,000 P154,000 P 0Net income 280,000 140,000 154,000

Balance at end of year P574,000 P294,000 P154,000b P100,000 x (1 0.30)c P250,000 x (1 0.30) + P70,000d [(P100,000 + P120,000) P100,000] x (1 0.30)e [(P100,000 + P120,000 + P125,000 + P75,000) (P100,000 + P250,000)]

x (1 0.30)

Note: The company has accounted for revenue and costs for long-term

construction contracts by the percentage-of-completion method in 2007, whereasin prior years revenues and costs were determined by the competed-contract

method. The new method of accounting for long-term contracts was adopted to

(state justification for change in accounting principle) and financial statements ofprior years have been restated to apply the new method retroactively. The effect

of the accounting change on income of 2007 and on income as previously reported

in 2005 and 2006 is as follows:

Increase

2007 2006 2005

Net income P(49,000) h P(35,000) g P84,000 f

Earnings per ordinary share P(0.49) P(0.35) P0.84

The balances of retained earnings and deferred taxes for 2006 and 2007 have been

adjusted for the after-tax effect of applying the new method of accounting

retroactively:

f (P220,000 P100,000) x (1 0.30)g (P200,000 P250,000) x (1 0.30)h [P400,000 (P820,000 P350,000)] x (1 0.30)


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Items Restated:

On the 2005 and 2006 income statements, construction revenues and expenseswould be restated to the appropriate amounts for the percentage of completion

method. The construction in progress, deferred income taxes, and retained

earnings on the balance sheets would also be restated.

19-10. Sand Company

Requirement (1)

a. Incorrect entries:

Building 60,000

Notes Payable 60,000

Depreciation Expense: Building

(P60,000 30) 2,000Accumulated Depreciation: Building 2,000

Correct entries:

Building 40,981a

Discount on Notes Payable 19,019

Notes Payable 60,000

a P60,000 x 0.683013

Depreciation Expense: Building 1,366b

Interest Expense 4,098 c

Accumulated Depreciation 1,366


b P40,981 30c Interest computed using effective

interest method: 10% x P40,981

Entries to correct error:


Building 19,019

Accumulated Depreciation: Building 634

Interest Expense 4,098Depreciation Expense: Building 634


b. Retained Earnings 40,000

Cost of Goods Sold 40,000

To correct error from prior year.


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Cost of Goods Sold 15,000

Inventory 15,000To correct error in current year.

c. The error from 2005 was counterbalanced atthe end of 2006, so it can be ignored.


Salaries and Wages Expense 18,000

To correct error in salary and wageaccrual in 2006.

Salaries and Wages Expense 10,000

Salaries and Wages Payable 10,000

To accrue salaries and wages at

December 31, 2007.

Requirement (2)

a. See Requirement 1.a. of this solution for the incorrect entries that were made

and the correct entries that should have been made.

Discount on Notes Payable (total discount

of P19,019 less amount of P4,098amortized for 2007) 14,921

Accumulated Depreciation: Building 634

Retained Earnings 3,464d

Building 19,019

d Correction of interest expenseunderstatement of P4,098 less

depreciation overstatement of P634

b. The error from 2006 was counterbalancedby the end of 2005, so it can be ignored.

Retained Earnings 15,000

Inventory 15,000

c. The errors from 2005 and 2006 were counterbalanced by the end of 2006 and

2007; respectively, so they can be ignored.

Retained Earnings 10,000Salaries and Wages Payable 10,000


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19-11. Play Company

Requirement (1)

SFAS No. 13 paragraphs 42 and 43 state that a change in accounting policy

should be applied retroactively unless the amount of any resulting adjustment thatrelates to prior periods is not reasonably determinable. Any resulting adjustment

should be reported as an adjustment to the opening balance of retained earnings.

Comparative information should be restated unless it is impracticable to do so.

The financial statements, including the comparative information for prior periods,are presented as if the new accounting policy had always been in use. Therefore,

comparative information is restated in order to reflect the new accounting policy.

The amount of the adjusting relating to periods prior to those included in thefinancial statements is adjusted against the opening balance of retained earnings of

the earliest period presented. Any other information with respect to prior periods,such as historical summaries of financial data, is also restated.

PLAY COMPANYWorksheet to Correct Income Before Income Taxes

Year Ended December 31

2007 2006

Income before income taxes, before adjustments P4,030,000 P3,330,000

Adjustments:

Depreciate certain equipment over 8-year life

instead of 10-year life (Schedule 1) (25,000) --

Correct 2006 error 180,000 (180,000)

Record 2007 provision for doubtful accounts(P58,500,000 x 0.2%) (117,000) --

Increase estimated warranty liability (170,000) --Effect of change in accounting principle from

expensing to capitalizing relining costs in the

year of the change (Schedule 2)

Furnace A (Jan. 2006) (56,000) 224,000

Furnace B (Jan. 2007) 240,000 --

Net adjustments 52,000 44,000

Income before income taxes P4,082,000 P3,374,000

Schedule 1:

Computation of Adjusted Depreciation

Cost of equipment (no salvage value) P1,000,000

Depreciation based on 10-year life P 100,000

Depreciation based on 8-year life (125,000)

Adjustment P (25,000)


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Schedule 2:

Computation of Effect of Change in AccountingPrinciple From Expensing to Capitalizing

Relining Costs on the Year of the Change

Capitalization of Furnace B P300,000

Depreciation on Furnace B based on 5-year life

(P300,000 x 20%) (60,000)Depreciation on Furnace A based on 5-year life

(P280,000 x 20%) (56,000)

Adjustment P184,000

Requirement (2)

PLAY COMPANY

Effect Before Income Taxes

of Change in Accounting Principle FromExpensing to Capitalizing Relining Costs

For Year Ended December 31, 2007

Capitalization of Furnace A P280,000Depreciation on Furnace A based on 5-year life

(P280,000 x 20%) (56,000)

Adjustment P224,000

19-12. Jo Francisco, Inc.

Net Income for 2005 Retained Earnings 12/31/06

Item Understated Overstated Understated Overstated

1. P14,100 0 0 0

2. P 7,000 0 P 5,000 03. 0 P22,000 0 P11,000

4. P33,000 0 P33,000 05. 0 P20,000 0 P10,000

6. P18,200 0 0 0

Although explanations were not required in answering the question, they are

included below for your interest.

Explanations:

1. The net income would be understated in 2005 because interest income is

understated. The net income would be overstated in 2006 because interest

income is overstated. The errors, however, would counterbalance (wash) sothat the Balance Sheet (Retained Earnings) would be correct at the end of

2006.


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2. The depreciation expense in 2005 should be P1,000 for this machine. Since

the machine was bought on July 1, 2005, only one-half of a year should betaken in 2005 (P8,000/4 X 1/2 = P1,000). The company expensed P8,000

instead of P1,000 so net income is understated by P7,000 in 2006. An

additional P2,000 of depreciation expense should have been taken in 2006. Atthe end of 2006, retained earnings would be understated by P5,000 (P7,000

P2,000).

3. PAS 38, paragraphs 54 to 57 govern the accounting for research and

development costs. Net income in 2005 is overstated P22,000 (P33,000

research and development costs capitalized less P11,000 amortized). By theend of 2006, only P11,000 of the research and development costs would

remain as an asset. Therefore, retained earnings would be overstated by

P11,000 (P33,000 research and development costs P22,000 amortized).

4. The security deposit should be a long-term asset, called refundable deposits.The P8,000 of last months rent is also an asset, called prepaid rent. The net

income of 2005 is understated by P33,000 (P25,000 + P8,000) because these

amounts were expensed. Retained earnings will continue to be understated by

P33,000 until the last year of the lease. The security deposit will then be

refunded, and the last months rent should be expensed.

5. P10,000 or one-third of P30,000 should be reported as income each year. In

2005, P30,000 was reported as income when only P10,000 should have been

reported. Because P20,000 too much was reported, the net income of 2005 is

overstated. At the end of 2006, P20,000 should have been reported as income,so retained earnings is still overstated by P10,000 (P30,000 P20,000).

6. The ending inventory would be understated since the merchandise wasomitted. Because ending inventory and net income have a direct relationship,

net income in 2005 would be understated. The ending inventory of 2005

becomes the beginning inventory of 2006. If beginning inventory of 2006 isunderstated, then net income of 2006 is overstated (inverse relationship). The

omission in inventory over the two-year period will counterbalance, and

retained earnings at the end of 2006 will be correct.

19-13. JC Patrick Corporation

2006 2007

Net income, as reported P29,000 P37,000Rent received in 2006, earned in 2007 (1,300) 1,300

Wages not accrued, 12/31/05 1,100

Wages not accrued, 12/31/06 (1,500) 1,500

Wages not accrued, 12/31/07 (940)Inventory of supplies, 12/31/05 (1,300)

Inventory of supplies, 12/31/06 740 (740)

Inventory of supplies, 12/31/07 1,420Corrected net income P26,740 P39,540

chapter19 - comprehensive audit of balance sheet and income statement accounts

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