2nd Flr, GF Partners Bldg, 139 H.V. dela Costa, Salcedo Village, Makati City

AUDITING PROBLEMSAccounting for Changes and Correction of Errors Prof. L.O. Aristorenas __ Definition of Terms

Accounting policies - specific principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting the financial statements.

Fundamental 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 why Accounting Changes Occur:1. The accounting profession may mandate that a new accounting principle is to

be used.2. Changing economic conditions3. Changes in technology and in operations4. New experience or new information may prompt companies to change its

estimate of revenues or expenses.

TYPES OF ACCOUNTING CHANGES1. Change in Accounting Principles

This is a change from one generally accepted accounting principle to another generally accepted accounting principle. Adoption of a new principle in recognition of events that have occurred for the 1st time is not a change in accounting principle. There is no change in accounting principle when the depreciation method adopted for a newly acquired asset is different from the method or methods used for previously recorded assets of similar class.

A change from a principle that is not generally accepted to one that is generally accepted is considered to be an error correction than a change in accounting principle.

Accounting Procedure:Benchmark treatment

A change in accounting policy/principle should be applied retroactively unless the amount of any resulting adjustment that relates to prior periods is not reasonably determinable. Any resulting adjustment should be reported as an adjustment to the opening balance of the retained earnings. Comparative information should be restated unless it is impracticable to do so.

2. Change in Accounting EstimateThis is a change that occur as a result of new information or acquisition of

additional experience. Changes in estimates are viewed as normal recurring corrections and adjustments or the natural result of the accounting process. Retroactive treatment is prohibited. Accounting Procedure:

a. Report current and future financial statements on the new basis.

1

b. Present prior period financial statements as previously reported.c. Make no adjustment to current period opening balances.

NOTE: Whenever it is impossible to determine whether a change in principle or a change in estimate has occurred, or if an asset is affected by both a change in principle and a change in estimate during the same period, the change should be accounted for as a change in estimate rather than a change in principle.

CORRECTION OF ERRORSNo company whether large or small is immune from errors. Errors may be

intentional or unintentional. Intentional errors are significant because of the presence of fraud or intent to deceive. These errors are made for the purpose of concealing fraud or misappropriation, evading taxes, manipulating or window-dressing the company's financial statements. Unintentional errors were not deliberately committed. They result from carelessness or ignorance on the part of the company's personnel or it may result from poor internal control.

The risk of material errors may be minimized through the installation of good internal control and the application of sound accounting procedures. Prior period adjustments, also called fundamental errors are reported in the current year as adjustment in the beginning balance of the Retained Earnings account. Prior period statements should be restated to correct the error when comparative statements are prepared.

Accounting Procedure:1. If detected in the period the error occurred, correct the accounts

through normal accounting cycle adjustments.2. If detected in subsequent period, adjust errors by making prior period

adjustments directly to Retained Earnings or restate the beginning balance of the Retained Earnings account.

3. Correct all previously presented prior period statements.

Examples of Accounting errors:a. A change from an accounting principle that is not generally accepted to an

accounting principle that is generally accepted.b. Mathematical mistakesc. Mistake in the application of accounting of accounting principled. Oversighte. Misuse of factsf. Incorrect classification of expense as an asset or vice versag. Changes in estimates which are not prepared in good faith

TYPES OF ERRORS1. Balance Sheet Errors

This type of error refers to improper classification of real accounts such as assets, liabilities or stockholders' equity accounts. They have no effect on net income2. Income Statement Errors

This type of error affects only the presentation of nominal accounts in the Income Statement. It involves the improper classification of revenues and expenses accounts, hence, only the details of the Income Statement are misstated. A reclassifying entry is necessary only if the error is discovered in the same year it is committed. It has no effect on the Balance sheet and in the Income Statement. If the error is discovered in a subsequent year, no classification entry is necessary.3. Combined Balance Sheet and Income Statement errors

This affects both the balance Sheet and the Income Statement because they result in the misstatement of net income.

2

Classifications of Combined Balance Sheet and Income Statement Errors:a. Counter Balancing Errors

Errors which if not detected are automatically offset or corrected over two periods. Restatement is necessary even if a correcting journal entry is not required.

Effect: Net Income of two successive periods are misstated. The amount of misstatement in one period is equal to but opposite in effect in the income of the next period.

Counterbalancing errors include the misstatements of the following accounts:

1. Inventories to include the following a. Purchases b. Sales2. Prepaid expenses3. Deferred Income4. Accrued expense5. Accrued Income

GUIDELINES Books are open

1. If the error is already counterbalanced and the company is in the second year, an entry is necessary to correct the current period and to adjust the beginning balance of the Retained earnings.

2. If the error is not yet counterbalanced, an entry is necessary to adjust the beginning balance of the Retained earnings and correct the current period.

Books are closed1. If the error is already counterbalanced, no entry is necessary.2. If the error is not yet counterbalanced, an entry is necessary to

adjust the present balance of the Retained earnings.

b. Non Counter Balancing Errors Errors which take longer than two periods to correct themselves. This

type of error is carried over to the subsequent accounting 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 ANALYSIS1. What accounts are affected?2. How were these accounts affected? Was there an understatement or an

overstatement?3. What was the erroneous entry made or what was the entry omitted?4. What is the correct entry?5. What is the necessary adjusting or correcting entry?

END

PROBLEM 1In your examination of the financial statements of GRISHAM CORP., for the

year ended December 31, 2004, you discovered the following errors. Prepare the necessary adjusting entries.1. Interest collection from a notes receivable amounting to P3,500 which was

received on December 30, 2004 was deposited and recorded on the same day by a credit to sales.

3

2. A staled check of P12,000 which had been outstanding for more than six months was included in the list of outstanding checks. This was in payment of Accounts Payable

3. Payment of P4,500 for freight charges on merchandise purchased on December 18, 2004 was debited to freight out account.

4. On December 31, 2003, the physical count was overstated by P5,000.5. Improvements on building of P100,000 had been charged to expense on

January 01, 2004. Improvements have a life of 5 years.6. GRISHAM CORP. issued 5,000 shares of P 100 par value capital stock for

P550,000 on January 14, 2003. The proceeds were credited to the Capital Stock account.

7. On January 01, 2004, an equipment costing P70,000 was sold for P35,000. At the date of sale, the equipment has an accumulated depreciation of P43,750. The cash received was recorded as other income in 2004.

8. A P15,000 collection from Smart Co. was correctly recorded in the general ledger but was erroneously credited to the subsidiary ledger account of Smurf Corp.

9. Insurance premium of P45,000 for three years paid in January 2003 was charged to

expenses in 2003.10. On December 31, 2003, goodwill estimated by the Board of Directors at

P300,000 was set up by a credit to Retained Earnings.11. On December 29, 2004, GRISHAM CORP. issued checks to its creditors amounting to

P75,000. These checks were released on January 4, 2005.12. A check for P20,000 from a customer to apply to his account was received on December

30, 2004 but was not recorded until January 4, 2005.13. A customer's deposit of P60,000 for goods to be delivered in January 2005

was deducted from accounts receivable.14. A check was cleared by the bank as P5,200 on December 05, 2003, but was recorded

by the bookkeeper as P2,500. This was in payment of an employee cash advance.15. On the last day of 2004, the company received a P90,000 prepayment from a

tenant for 2005 rent of a building. It was recorded as rent revenue.

PROBLEM 2In early 2005, while reviewing KEVIN INC.’s 2004 financial records, KEVIN

INC.s accountant discovered several errors. For each of the error listed below, indicate the effect on net income for both 2003 and 2004 and the necessary adjusting entries, assuming :

a. books are still openb. books are already closed

1. KEVIN INC. frequently borrows from the bank in order to maintain sufficient operating cash. The following loans were at 12% interest rate, with interest payable at maturity. KEVIN INC. repaid each loan on its scheduled maturity date.

DATE OF LOAN AMOUNT MATURITY DATE11.01.03 50,000 10.31.04

02.01.04 150,000 07.31.04 05.01.04 80,000 01.31.05

KEVIN INC. records interest expense when the loans are repaid. As a result, interest

expense of P15,000 was recorded in 20042. Pollution control devices costing P84,000 which is high in relation to the cost of the original equipment, were installed in 2003 and were charged to repairs in 2003. The original equipment referred to has a remaining useful life of 6 years on December 30, 2003 and is being depreciated using the straight line method. Assume tax rate of 32%.

4

3. KEVIN INC. receives subscription payments for annual (one year) subscriptions to its magazine. Payments are recorded as revenue when received. Amounts received but unearned at the end of each of the last three years are shown below.

2002 2003 2004

Unearned revenues P240,000 P300,000P352,000KEVIN INC. failed to record the unearned revenues in each of the three

years. 4. KEVIN INC. has estimated bad debts using the percentage-of-sales method since their business began operations in 2002. Information relating to bad debts and sales is as follows:

Estimated BadDebt Expense Actual

Year Sales (% of Sales) Bad Debts2001 P 87,000 P2,610 P1,2002002 123,000 3,690 2,8502003 147,000 4,410 3,222

At the beginning of 2004, KEVIN INC. proposes changing their estimation of bad debt expense from 3 percent of sales to 2 percent. Sales for the year totaled P1,630,000 and actual bad debts amounted to P3,720. The company had already made an adjustment based on the old rate.5. Beginning merchandise inventory (January 01, 2003) was understated by P8,640.6. Merchandise costing P24,000 was sold for P40,000 on December 29, 2003 but the sale was recorded in 2004. The merchandise was shipped FOB shipping point and was not included in ending inventory.7. A one-year note receivable of P96,000 was held by KEVIN INC. beginning October 1, 2003. Payment of the 10 percent note and accrued interest was received upon maturity. No adjusting entry was made on December 31, 2003.8. Equipment with a ten-year life was purchased on January 1, 2003, for P39,200. No depreciation expense was recorded during 2003 or 2004. Assume that the equipment has no salvage value and that KEVIN INC. uses the straight-line method for recording depreciation.9. A two-year fire insurance policy was purchased on May 1, 2003, for P57,500. The entire amount was debited to Prepaid Insurance. No adjusting entry was made in 2003 or 2004. 10. Accrued expenses omitted at the end of the year are P43,000 in 2002, P43,000 in 2003 and P92,000 in 2004.

PROBLEM 3You have been engaged to audit the accounts of EFU CORP. for the first time

in 2004. During the audit you found the following: Year ending December 31

2002 2003 2004Omissions from the books:a. Accrued expenses, Dec. 31 P18,000 P27,000 P9,000b. Accrued income, Dec. 31 3,600 4,050 3,150c. Prepaid expenses, Dec. 31 108,000 81,000 54,000d. Unearned income. Dec. 31 31,500 22,500 13,500

REQUIREMENTS: a. For each number indicate the effect by writing O for overstated, U for understated or X for no effect.

b. Indicate the amount of over or under statement. EFFECT AMOUNT

5

__________________1. On 2004 net income of the omission of both accrued expense and

unearned income at the end of 2002, 2003 and 2004 when considered together.

__________________2. On Retained Earnings after closing at Dec. 31, 2004 of the omission unearned income at the end of 2002, 2003 and 2004.

__________________3. On working capital at December 31, 2004 of the omission of accrued income at the end of 2002, 2003 and 2004 when considered together.

__________________4. On working capital at Dec. 31, 2004 of the omission of unearned

income at the end of 2002, 2003 and 2004. __________________5. On Retained Earnings after closing at Dec. 31, 2004 of the omission

of accrued expenses at the end of 2002, 2003 and 2004.__________________6. On working capital at Dec. 31, 2004 of the omission of prepaid

expenses at the end of 2003 and 2004.__________________7. On Retained Earnings after closing at Dec. 31, 2004 on the omission

of prepaid expenses at the end of 2002 and 2003.__________________8. On 2003 net income of the omission of accrued expenses at the

end of 2002.__________________9. On 2004 net income of the omission of accrued income at the

end of 2002, 2003 and 2004 when considered together. __________________10. On the 2003 net income of the omission of both accrued income

and prepaid expense at the end of 2002 and 2003.__________________11. On the 2004 net income of the omission of prepaid expenses at

the end of 2003 and 2004.__________________12. On 2004 net income of the omission unearned income at the

end of 2002 and 2003.__________________13. On Retained Earnings before closing at Dec. 31, 2002 of the

omission of accrued income at the end of 2002.__________________14. On the 2004 net income of the omission of accrued expenses at

the end of 2002, 2003 and 2004 when considered together.__________________15. On Retained Earnings after closing at Dec. 31, 2004 of the

omission of both accrued expenses and unearned income at the end 2002, 2003 and 2004 when considered together.

PROBLEM 4An examination of the accounting records of Mervyn Company for the year

ended December 31, 2004 indicated that several errors were committed as follows:

1. Purchase of merchandise in the amount of P10,625 in 2003 was not recorded until the following year but was included in the year's inventory.

2. In August 2004, an P8,750 invoice for office supplies was charged to purchases. Office supplies are expensed as purchased.

3. Inventory on December 31, 2004 was overstated by P56,250.4. An equipment costing P125,000 and with an accumulated depreciation of

P75,000 was sold for 68,750 on January 1, 2004. In addition, depreciation was recorded for the equipment for 2004 at the rate of 10%. Proceeds from sale was credited to the Equipment account.

5. Footings and extensions showed that the inventory on December 31, 2003 was overstated by P 59,375.

6. Depreciation of equipment costing P15,000 bought on June 30, 2001 was computed based on an estimated useful life of 8 years. The engineers

6

estimated that the useful life of the asset should be revised to 10 years effective 2004. The company still provided for depreciation based on the old estimate.

7. Interest of P6,250 on notes receivable was not recognized on December 31, 2004.

8. Sales on account of P25,000 in December 2004 were recorded in 2005.9. Taxes of P18,750 applicable for the fourth quarter of 2003 were paid and

charged to expense on January 20, 2004. 10. A fully depreciated machinery was sold on December 31, 2004 but the sale

was not recorded until 2005. The proceeds from sales on this machinery costing P437,500 was P31,250.

11. On December 20, 2003, a cash advance of P37,500 from a customer was received for goods to be delivered in January 2004. The amount of cash received was credited to sales. The company's gross profit is 20% of cost.

12. Insurance premium for a three year period amounting to P15,000 was charged to expense on January 1, 2003 and no adjustment was made on year end.

13. A collection of P31,250 from a customer was received on December 31, 2004 but not recorded until January 4, 2005.

14. A customer's check of P8,750 was returned by the bank on November 3, 2004 due to lack of sufficient funds. Adjustment was made the following year.

15. Depreciation computed on the building for the years 2003 and 2004 was overstated by P12,500 per year.

Records of Mervyn Company reported the following net Income.2003 P 546,8752004 625,000

REQUIREMENTS:1. Prepare a worksheet showing the corrected income for 2003 and 2004.2. Prepare the necessary adjusting entries on December 31, 2004 assuming:

a. Books are still openb. Books are closed

Problem 5In early 2005, while reviewing THOMAS CORP.'s 2004 financial records, its

accountant discovered several errors. For each of the error listed below, indicate the effect on net income for both 2003 and 2004 assuming no correction was made and the company uses the periodic system of inventory.

1. Goods shipped to consignee amounting to P2,500 in 2003 were reported as sales. Goods in the hands of the consignee at the end of 2003 were not recognized for inventory purposes. Sale of such goods in 2004 and collections on such sales were recorded as credits to receivables established with consignees in 2003.

2. Insurance costs incurred amounting to P15,000 but unpaid in 2003 were not recorded until paid in 2004.

3. The total of one week's sales amounting to P2,250 in 2003 was credited to Gain on sales-Machineries

4. 2003 year end purchases of P10,000 were not recorded until the beginning of 2004. The inventory associated with these purchases was omitted from the ending inventory count in 2003.

5. Machinery was sold in May of 2004, but the company continued to deduct depreciation for the remainder of 2004 although the asset was removed from the books in May. Cost of the asset purchased in October of 2001 was P12,500 and estimated to have a useful life of 10 years, The company follows the straight line method of computing depreciation.

6. A check of P6,250 for January 2004 rent was received and recorded as revenue at the end of 2003.

7

7. 2003 year end purchase of P7,500 of inventory were not recorded until the beginning of 2004 although the inventory was correctly counted at the end of 2003.

8. Interest receivable of P1,500 in 2003 was not recorded until 2004.9. Interest accrued of P4,000 in 2003 on a note payable was not recorded until

it was paid in 2004.10. Certain items of ending inventory amounting to P5,875 were accidentally not counted at

the end of 2003.11. Goods sold on account in 2003 amounting to P5,000 were not recorded as

sales until 2004.12. No depreciation amounting to P4,375 was taken in 2003 for equipment sold

in April 2003. The company reports on a calendar year basis and computes depreciation to the nearest month.

REQUIREMENTS: Determine the effect of the above mentioned errors on the balance sheets and the income statement prepared in 2003 and 2004 and compute for the corrected income assuming reported income are as follows:

2003 P 500,0002004 375,000

Problem 6For three years, BLUEBIRDS MDSE. failed to recognize accruals, prepayments

and other transactions in its accounts. Reported net income and listing of the error appear below:

2002 2003 2004Unadjusted net income (loss) 150,000 500,000 ( 125,000)1. Checks written in December and mailed on January 3

of the following year. 250 375 5002. Overstatement of ending inventories 36,000 28,000 -3. Failed to recognize unearned revenue - 6,250 11,2504. Failed to record purchase on account and mdse

properly included in ending inventory - - 50,0005. Failed to recognize unused supplies at the end of year 3,750 - 5,0006. Failed to record accrued commission expenses 25,000 31,250 60,0007. Understatement of depreciation expenses 15,000 18,750 18,7508. Worthless accounts written not written off by year end 625 750 8759. Failed to recognize gain on sale of land; Land credited for

the proceeds 75,00010. Failed to record accrued salaries 16,250 22,500 -

Requirements: Prepare a schedule to correct the reported net income for each year and the adjusting entries to correct the books at the end of 2004.

Problem 71. MYSTERYSCOT MANUFACTURING purchased a machine on January 1, 2000 for P50,000. At the time, it was determined that the machine has an estimated useful life of 10 years and an estimated residual value of P2,000. The company used the double declining balance method of depreciation. On January 1, 2004, the company decided to change its depreciation method from double declining balance to straight line. The machine's remaining useful life was estimated to be 5 years with a residual value of P 1,000.2. No allowance had been set up for estimated uncollectible receivables. The company decided to set up such an allowance for the estimated probable losses as of December 31, 2003, for 2003 accounts of P350 and for 2004 accounts of P750. It

8

was also decided to correct the charge against each year so that it shows the losses (actual and estimated) relating to that year's sales. Accounts have been written off to bad debts expenses as follows:

In 2003 In 20042003 accounts P 200 P 1,0002004 accounts 800

3. Equipment acquired by MYSTERYSCOT MANUFACTURING for P30,000 on June 30, 2002 was sold for P26,000 cash on July 1, 2004. The proceeds from the same were credited to the equipment account. The company depreciates equipment at 10% a year. Depreciation is taken up at year- end computed on a monthly basis. Depreciation of P1,600 was recorded in 2004.4. On May 01, 2002, MYSTERYSCOT MANUFACTURING acquired a machine in exchange for 1,000 shares of its own P100 par value common stock having a fair market value of P120 on this date. The machine was recorded in the accounts at P100,000. Company policy is to take one half years depreciation on all asset acquisitions or disposals during the year. Machinery is depreciated on a straight line basis (no salvage value based on an estimated life of 10 years.) The company has recorded depreciation charge of P1,500 on this machine from acquisition to the end of the current period.5. MYSTERYSCOT MANUFACTURING purchased a machine on January 1, 2001 for P1,500,000. At the date of acquisition, the machine had an estimated useful life of 6 years with no residual value. The machine is being depreciated on a straight-line basis. On January 1, 2004, management determined as a result of additional information, that the machine had an estimated useful life of 8 years from the date of acquisition with no residual value.

REQUIREMENT: Journal entries

PROBLEM 8INVENTORIES

1. You are examining the financial statements of DON JOHN CORPORATION which ends on December 31. DON JOHN CORP. uses the physical inventory system of accounting for inventory. In the course of your examination, you discovered the errors below.

1. Goods received in January 2005 were recorded as purchase on account in December 2004. The goods were included in the 2004 ending inventory.2. The inventory at December 31, 2004 is understated as a result of errors in physical count.3. Goods received in December 2004 were recorded as purchases when paid in 2005. The goods were excluded from the 2004 ending inventory.4. The inventory at December 31, 2004 is overstated as a result of the inclusion of goods acquired on consignment.5. Goods received in January 2005 were recorded as purchase on account in December 2004. The goods were excluded from the 2004 ending inventory.6. Goods received in December 2004 were recorded as purchases when paid in 2005. The goods were included in the 2004 ending inventory.

Enter the effect of the errors in the solution guide below. Use the following symbols: O-Overstated, U-Understated X-No effect

1 2 3 4 5 6Income Statement- 2004Purchases ____ ____ ____ _____ _____ _____Cost of Sales ____ ____ ____ _____ _____ _____ Net income ____ ____ ____ _____ _____ _____Balance Sheet- December 31, 2004Inventory ____ ____ ____ _____ _____ _____Accounts Payable ____ ____ ____ _____ _____ _____RE before closing ____ ____ ____ _____ _____ _____RE after closing ____ ____ ____ _____ _____ _____

9

Income Statement- 2005Purchases ____ ____ ____ _____ _____ _____Beginning inventory ____ ____ ____ _____ _____ _____ Ending inventory ____ ____ ____ _____ _____ _____Cost of Sales ____ ____ ____ _____ _____ _____ Net income ____ ____ ____ _____ _____ _____

Balance Sheet- December 31, 2005Inventory ____ ____ ____ _____ _____ _____Accounts Payable ____ ____ ____ _____ _____ _____RE before closing ____ ____ ____ _____ _____ _____ RE after closing ____ ____ ____ _____ _____ _____

Problem 9

Inventory Errors (Periodic Inventory System)1. 2003 sales were recorded in 2004; goods were included in the 2003 ending inventory.2. 2004 sales were recorded in 2003; goods were included in the 2003 ending inventory.3. 2003 sales were recorded in 2004; goods were excluded from the 2003 ending inventory.

4. 2004 sales were recorded in 2003; goods were excluded from the 2003 ending inventory.

A B C D Income Statement- 2003

Sales ____ _____ _____ _____ Ending inventory ____ _____ _____ _____ Cost of Sales ____ _____ _____ _____ Net income ____ _____ _____ _____

Balance Sheet- December 31, 2003 Inventory ____ _____ _____ _____

Accounts PAYABLE ____ _____ _____ _____ RE before closing ____ _____ _____ _____ RE after closing ____ _____ _____ _____ Income Statement- 2004

Sales ____ _____ _____ _____ Beginning inventory ____ _____ _____ _____ Ending inventory ____ _____ _____ _____ Cost of Sales ____ _____ _____ _____ Net income ____ _____ _____ _____ Balance Sheet- December 31, 2004

Inventory ____ ____ _____ _____ Accounts Payable ____ _____ _____ _____ RE before closing ____ _____ _____ _____

RE after closing ____ _____ _____ _____

Problem 10You have been engaged to prepare the corrected financial statement figures

for HASSAN INC. The records are in agreement with the following balance sheet:

Hassan Inc.Balance Sheet

December 31, 2004

ASSETS LIABILITIES AND CAPITALCash 192,500 Accounts payable 175,000

1

Accounts receivable 192,500 Notes payable 52,500

Notes receivable 227,500 Common stock350,000

Inventory 437,500 Retained earnings 472,500Total 1,050,000 Total 1,050,000

A review of the records of the corporation indicates that the errors and omissions listed in the table below had not been corrected during the applicable years.

2001 2002 2003 2004Overstatement of inventory - 122,500 140,000

-Understatement of inventory 105,000 - -

157,500Prepaid expense 15,750 12,250 8,750 10,500Unearned revenue - 7,000 - 5,250Accrued expenses 3,500 1,310 1,750 875

Net income as reported 131,250 113,750 96,250

No dividends were declared during the years and no adjustments were made to retained earnings.

REQUIREMENTS:Working paper to compute for the corrected income for the years 2002, 2003

and 2004.Prepare a corrected balance sheet for December 31, 2004.

MULTIPLE CHOICE PROBLEMS:1. Sean Company’s beginning inventory at January 1, 2004 was understated by P45,500, and its ending inventory was overstated by P91,000. As a result, Sean Company’s cost of goods sold for 2004 was:

a. Understated by P45,500b. Overstated by P45,500c. Understated by P136,500d. Overstated by P136,500

2. On January 1, 2002, Breton Company purchased for P420,000 a machine with a useful life of 10 years and no salvage value. The machine was depreciated by the double declining balance method and the carrying amount of the machine was P268,800 on December 31, 2003. Breton Company changed to the straight line method on January 01, 2004. What would be the depreciation expense on this machine for the year ended December 31, 2004?

a. P 26,880b. P 33,600c. P 42,000d. P 53,760

3. Brandy Corp. reports on a calendar-year basis. Its 2004 and 2005 financial statements contained the following errors:

2004 2005Over (under) statement of ending inventory P10,000 P 4,000Understatement of depreciation 4,000 6,000Failure to accrue salaries at year end 8,000 12,000

As a result of the above errors, 2005 income would be:

1

a. overstated by P4,000b. overstated by P24,000c. overstated by P22,000d. overstated by P16,000

4. On January 01, 2001, Laden Company purchased a patent for P535,500. The patent is being amortized over its remaining life of 15 years expiring January 01, 2016. During 2004, Laden Company determined that the economic benefits of the patent would not last longer than 10 years from the date of acquisition. What amount should be reported in the Balance sheet for the patent, net of accumulated amortization on December 31, 2004?

a. P 321,300b. P 367,200c. P 378,000d. P 392,700

5. Effective January 2, 2005, Kincaid Co. adopted the accounting principle of expensing advertising and promotion costs as they are incurred. Previously, advertising and promotion costs applicable to future periods were recorded in prepaid expenses. Kincaid can justify the change, which was made for both financial statement and income tax reporting purposes. Kincaid's prepaid advertising and promotion costs totaled P250,000 at December 31, 2004. Assume that the income tax rate is 40 percent for 2004 and 2005. The adjustment for the effect of the change in accounting principle should result in a net charge against income in the income statement for 2005 of

a. P 0b. P 100,000c. P 150,000d. P 250,000

6. On January 01, 2001, Rodney Company purchased a machine for P396,000 and depreciated it using the straight line method using an estimated useful life of 8 years with no salvage value. On January 1, 2004, Rodney Company determined that the machine had a useful life of six years from the date of acquisition and will have a salvage value of P36,000. An accounting change was made in 2001 to reflect this additional data. The accumulated depreciation for this machine should have a balance at December 31, 2004 of:

a. P 219,000b. P 231,000c. P 240,000d. P 264,000

7. Bart, Inc. receives subscription payments for annual (one year) subscriptions to its

magazine. Payments are recorded as revenue when received. Amounts received but unearned

at the end of each of the last three years are shown below: 2003 2004

2005Unearned revenues P120,000 P150,000

P176,000

Bart failed to record the unearned revenues in each of the three years. As a result of the omission, 2005 income was:

a. overstated by P146,000b. understated by P146,000c. understated by P26,000d. overstated by P26,000

8. Globe Corporation offers a 3 year warranty for its products. It previously estimated warranty costs to be 2% of sales. Due to technological advance in production at the beginning of 2004, Globe Corporation now believes 1% of sales to be a better estimate of warranty costs. Warranty cost of P140,000 and P168,000 were reported in 2002 and 2003 respectively. Sales for 2004 was P8,750,000. How much should be reported in 2004 as warranty expense.

a. P 87,500

1

b. P 154,000c. P 175,000d. P 241,500

9. An insurance premium of P3,600 was prepaid in 2004 covering the years 2004, 2005, and 2006. The entire amount was charged to expense in 2004. In addition, on December 31, 2005, fully depreciated machinery was sold for P6,400 cash, but the sale was not recorded until 2006. There were no other errors during 2004 or 2005, and no corrections have been made for any of the errors. Ignore income tax considerations. What is the total effect of the errors on 2005 net income?

a. Net income is understated by P12,800b. Net income is overstated by P3,600c. Net income is understated by P1,600d. Net income is overstated by P2,400

10. Adger Corporation purchased a machine for P150,000 on January 1, 2004. Adger will depreciate the machine using the straight-line method using a five-year period with no residual value. As a result of an error in its purchasing records, Badger did not recognize any depreciation for the machine in its 2004 financial statements. Adger discovered the problem during the preparation of its 2005 financial statements. What amount should Adger record for depreciation expense on this machine for 2005?

a. P 0b. P 30,000c. P 37,500d. P 60,000

11. On January 1, 2002, Gray Company purchased for P240,000 a machine with a useful life of ten years and no salvage value. The machine was depreciated by the double-declining-balance method, and the carrying amount of the machine was P153,600 on December 31, 2003. Gray changed retroactively to the straight-line method on January 1, 2004. Gray can justify the change. What should be the depreciation expense on this machine for the year ended December 31, 2005?

a. P 15,360b. P 19,200c. P 24,000d. P 30,720

12. Lain Company reported net income of P375,000 in 2004. Your audit disclosed the following errors:

Income received in advance in 2004 of P18,750 was credited to a revenue account when received. Of the total P3,750 was earned in 2004, P9,000 will be earned in 2005 and the remainder in 2006. P11,250 loss on sale of equipment in 2004 was erroneously debited to retained earnings.

What is the correct net income for 2004? a. P 348,750

b. P 363,750c. P 369,750d. P 345,000

13. Jerry Company reported a net income of P525,000 in 2004. Your audit disclosed the following:

2004 2005Overstatement of ending inventory 21,75024,750Omission of depreciation 11,250 11,250Understatement of commission receivable 16,50013,500Purchase of mdse not recorded but included in

the year end inventory 45,000Adjusted net income for 2004 is:

a. P 525,000b. P 507,750c. P 531,000d. P 552,750

1

14. Kentucky Enterprises purchased a machine on January 2, 2004, at a cost of P120,000. An additional $50,000 was spent for installation, but this amount was charged erroneously to repairs expense. The machine has a useful life of five years and a salvage value of P20,000. As a result of the error,

a. Retained earnings at December 31, 2005 was understated by P30,000 and

2005 income was overstated by P6,000.b. Retained earnings at December 31, 2005 was understated by P38,000 and

2005 income was overstated by P6,000.c. Retained earnings at December 31, 2005 was understated by P30,000 and

2005 income was overstated by P10,000.d. 2004 income was understated by P50,000.

15. On December 30, 2004, Saugie Corporation sold merchandise for P56,250 to Steve Company. The terms of the sale were net 30 days, DOB Shipping point. The merchandise was shipped on December 31, 2004 and arrived at Steve Company on |January 05, 2005. Due to clerical error, the sale was not recorded until January 2005 and the merchandise, skid at a 25% markup on cost was included in Saugie’s inventory at December 31, 2004. As a result, Saugie’s cost of goods sold for the year ended December 31, 2004 was:

Understated by P56,250Understated by P45,000Understated by P11,250Correctly stated

Items 16 and 17 are based on the following information:You were engaged as an independent auditor of Thomas Corporation . In the

course of your examination of the accounts on December 31, 2004, the end of the accounting period, you determined that certain prepaid and accrued items were not recorded in prior years and in the current year as follows:

2002 2003 2004Accrued expenses 4,500 7,500 6,500Prepaid expenses 5,000 12,000 8,000Prepaid revenues 1,200 2,750Revenues receivable 3,000 2,500Retained earnings at the end of 2002 amounted to P445,000 while net

income for 2003 was reported at P126,000. The income summary account for 2004 shows a credit balance of P150,000 before any audit adjustments. You have verified that no dividends were declared in the two year period.16. Compute for the corrected Retained earnings balance as of December 31, 2002.

a. P 444,300b. P 450,000c. P 578,500d. P 445,000

17. The corrected net income for the years ended December 31, 2003 and 2004 are:

2003 2004a. P126,000 P150,000b. P134,200 P143,750c. P146,700 P168,000d. P122,200 P155,750

18. On January 1, 2002, Carnival Shipping bought a machine for P1,500,000. At that time, this machine had an estimated useful life of six years, with no salvage value. As a result of additional information, Carnival determined on January 1, 2005, that the machine had an estimated useful life of eight years from the date it was acquired, with no salvage value. Accordingly, the appropriate accounting change was made in 2005. How much depreciation expense for this machine should Carnival record for the year ended December 31, 2005 assuming Carnival uses the straight-line method of depreciation?

1

a. P 125,000b. P 150,000c. P 187,500d. P 250,000

19. Combs, Inc. is a calendar-year corporation whose financial statements for 2004 and 2005 included errors as follows:

Ending Inventory Depreciation Expense2004 P30,000 overstated P25,000 overstated2005 P10,000 understated P 8,000 understated

Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2004, or December 31, 2005. Ignoring income taxes, by how much should Coombs' retained earnings be retroactively adjusted at January 1, 2006?

a. P 27,000 increaseb. P 27,000 decreasec. P 7,000 decreased. P 3,000 decrease

20. Koppell Co. made the following errors in counting its year-end physical inventories:

2003 P 60,000 overstatement2004 108,000 understatement2005 90,000 overstatement

As a result of the above undetected errors, 2005 income wasa. Understated by P18,000b. Overstated by P198,000c. Overstated by P18,000d. Understated by P198,000

21. Koppell Co. made the following errors in counting its year-end physical inventories:

2003 P 60,000 overstatement2004 108,000 understatement2005 90,000 overstatement

The entry to correct the accounts at the end of 2005 isa. Retained earnings 48,000

Cost of sales 42,000Inventory 90,000

b. Retained earnings 18,000Cost of sales 72,000

Inventory 90,000

c. Inventory 90,000Cost of sales 18,000Retained earnings 72,000

d. Cost of sales 198,000Retained earnings 108,000Inventory 90,000

22. In the course of your examination of the financial statements of Correa Corp., a new client, for the year ended December 31, 2004, you discovered the following:

a. Inventory at January 01, 2004 had been overstated by P33,750.b. Inventory at December 31, 2004 was understated by P56,250.c. An insurance policy covering three years had been purchased on

January 01, 2003 for P22,500. The whole amount was charged to expense in 2003.

d. During 2004, the company received a P15,000 cash advance from a customer for goods to be manufactured and shipped during 2005. The amount received was credited to sales.

1

Income reported for 2004 before reflecting any adjustment for the above information is P187,500. The correct income for 2004 is:

a. P 255,000b. P 221,250c. P 165,000d. P 150,000

23. Tom Company’s beginning inventory at January 01, 2004 was understated by P45,500 and its ending inventory was overstated by P91,000. As a result, Tom Company’s cost of goods sold for 2004 was:

a. Understated by P45,500b. Overstated by P45,500c. Understated by P136,500d. Overstated by P136,500

24. The net income for 2004 reported by the accountant of Abbas Company amounted to P634,500. Your audit of the accounts disclosed that the following accounts were not recorded:

2003 2004Rent received in advance 22,500 30,000Accrued salaries 13,500 18,000Prepaid interest 33,750 45,000Commission receivable 15,750 14,625Depreciation expense 26,25026,250Equipment purchased at year end charged

to expense (10 year life) 75,000

Compute the correct income for the year ended December 31, 2004.a. P 598,875b. P 613,875c. P 655,125d. P 681,375

25. The first examination of Tamer’s financial statements was made for the year ended December 31, 2004. The auditor has found that Tamer had purchased another company in January 2002 and recorded goodwill of P75,000 in connection with this purchase. It was determined that the goodwill had an estimated useful life of only five years because of obsolescence. No amortization of goodwill had ever been recorded.

For the December 31, 2004 financial statements, Tamer should debit amortization expense of:

Amortization expenses Retained earningsa. P 0 P75,000b. P15,000 P30,000c. P25,000 P 0d. P45,000 P 0

END

1