AUDITING PROBLEMS IRENEO/ESPENILLA/JAMES PAS 8: ACCOUNTING CHANGES AND ERROR CORRECTIONS Prior Period Errors ~ The entity shall correct material prior period errors retrospective in the first set of financial statements authorized for issue after their discovery by restating the net income and retained earnings of prior period. Two types of prior period errors: A. Counterbalancing errors — errors that affect both the net income of the year when the error was committed and the immediate year thereafter in opposite directions. Counterbalancing errors affect pertinent real accounts only in the year of the commission of error. Real accounts subsequent to the year of error are already correctly stated. Examples of counterbalancing errors aes i oe: te Fo © * Omission of Accrued Expenses BADR EO ee A © Omission of Unearned Income a apm © 4 ee * Omission of Accounts Payable/Purchases sagut Or OO + Omissions of Prepaid expenses : oo * Omission of Accrued Income 8, = * Omission of Accounts Reccivables/Sale> MR ” = Understatement of Ending inventories Mi aod pes, * Overstatement of Ending Inventories decbe/ ober f reac te we B. Non-counterbalancing errors ~ errors that affect only the net income of the year the error was committed. The net income of the subsequent year is already correctly stated. Non- counterbalancing errors affect pertinent real accounts in the year the error was committed and all the subsequent years, unless adjusted. PROBLEM 1:The first audit of the books of Rafael Company was made for the year ended December 31, 2013. In reviewing the books, the auditor discovered that certain adjustments had either been overlooked or improperly recorded at the end of 2011, 2012 and 2013. Gross profit is 20% of sales. Omissions and other failures for each year are summarized below. — | Oeeenberst nea 2011/2012} 2013 | ao 2082 | 2013 | Omissions of the following accounts: _ | a. Accrued interest income 4. _b. Merchandise Inventory 1 c. Accounts Receivable 4 (d. Prepaid Expenses 4. “e. Advances to suppliers E "Over recording of the following accounts: Z 4 a eee 18,000 ; 1, Sales _ = 4 ig. Merchandise inventory 2. ¢-) 3 | 19,000 ; 20,000 : 22,000)PSaeA Eee root h. Accrued rent expense ® “| 22,000 | 23,600 | 24,000 | i. Accounts Payable 3 25,000 | 26,000 | 27,000 | }, Unearned commission income 8 28,000 ; 29,000 | 70,000 | k Advances from customers 4 31,000 | 32,000 | 33,000 | | | 34,000 | 35,000 | 36,000 | Mayor expenditures had been recognized as repairs, but should have been capitalized as cost of equipment; annual depreciatimnrate on 6 20% , but depreciation in the year of the Lexpenditure is at 10% such equipmer Required, 1. Prepare the audit adjustments assuming that the errors were discovered in your audit period ended December 31, 2013. 2. Assuming the unadjusted net income for the years 2011, 2012 and 2013 were P90,000; 87,000 and P78,000, respectively, compute for the adjusted net income. 46 j 1lo7 7560 3. Assuming that the unadjusted retained earnings balance at the end of 2011, 2012 and 2013 were P90,000, PL77,000 and 266,000, respectively, compute for the adjusted balances of retained earnings, Heor / (03,300 / 220,900 4, What are the effects of the errors on the 2011, seyzans 2013 working capital? (Myer) /(lor,re)/ (109,080 ey done) (1 PROBLEM 2: The December 31 year-end financial statements of Sam Co. contained the following errors: “December 31,2010 "December 31,2011 Ending inventory 48,000 understated? 40,500 overstated C2 Accrued expenses 16,000 understated3. ‘22,000 understated (3) Depreciation Expense 11,500 understated NIE 0- WORE (BAED-reovcider a9 NODE An insurance premium of P24,000 was paid in advance in 2010 covering'the years 2010, 2021 and 2012. The entire amount was charged to expense in 2010. In addition, on December 31, 2010, 3 fully depreciated machinery was sold for P:18,000 cash, but the sale was not recorded until 2011, There were no other errors during 2010 andPO11, and no corrections have been made for any of the errors. Ignore income tax effects, Cab rd eed. 1. What is the total effect of the errors on Sam’s 2011 net income? (/4o,s>9) > 2. What is the total effect of the errors on Sam’s working capital at December 31, 2011? (54.5%) ey 3. What is the total effect of the errors on Sam's retained earnings at December 31, 2011? (Gy ry Jaw PROBLEM 3: Bee Co.'s net income for 2009, 2010 and 2011 were P100,000, P145,000 and P 185,000; respectively. The following items were not handled properly, a. Rent of P9,000for 2011was received from a lessee on December 23, 2010, and recorded as outright income in 2010. ype 8) 200 b. Salaries payable at the end of the following years were omitted: (Type %) [December 31, 2008" [December 32, 200: | 2500] 35001[December 31, 2010 ____|.4500 | [December 31, 2011 | 5,500 c. The following unused office [December 31, r | December 31, [December 31, December 31, 2011 Z ~_ | 6,700 d. On January 1, 2009, the company completed major repairs on the company’s machinery and equipment totaling P88,000, which was expensed outright. The said equipment 1s 5 years old a5 of January 1, 2009. As of December 31, 2011, the equipment had an original cost of 500,000 and a carrying value of P250,000. Nemé ‘A. Compute for the adjusted balances of the following: 1. 2011depreciation expense 127 2. 2009 net income 3. 2010 net income c 4. 2011 net income 8. Compute for the effects of the errors on the following: 5. 2011 beginning retained earnings = 70° e gale 6. 2011 working capital PROBLEM 4:You are auditing the financial statements of Art Inc. for the year 2011. The details of the company’s Accumulated Profit account, before any adjustments, are as follows: ACCUMULATED PROFIT Date [Particulars | peste] [? | | 01.01. 2009 | Balance | 870,000 | | 12.31. 2009 | Net income for the year | 465,000 | 1,335,000 | | 1,125,000 | | 04.01 2010 | Paid in Capital in excess of par | 08.30 2010 | Gain on retirement of preference 135,000 | 1,260,000 | |.01.31 2010 | Dividends paid | 210,000 | | 96,750 | 1,356,750 | | 12.31 2010 | Net loss for the year 307,500 1,049,250 | | 03. 31 2011 | Dividends paid | 150,000. | 899,250 | | 12.31 2011. | Net loss for the year | 248,250 | _ | 651,000) Your examination disclosed the following: a. The following were omitted at the end of each year 2011. 2010 2009 2008 ye 1 Accrued income £ 11,700. 9,300.04 8,400!" 7,050 I Prepayments | 14,250. 11,1005) 9,300 12,750 ae tt Unearned income 14,400 44" 13,3500" ~ 11,700" ~ 10,350 qDAccrued expenses > 13,500 13,050 ve 4 ,10,98027 45 8,100 615 b. Dividends had been declared in 2009 and in 2010 but were not recorded until paid the following year, Dividends declared in December2011,but paid and recorded only in 2012amounted to P125,000.WRI ev t/m./ 4. ‘Cees TE BOVEWSICNOO! OF ACCOUNTaNCy Page 4 Of 6 The company received transportation equipment as donation from one of its stockholders on September 30, 2010. As of the date of danation, the equipment ths historical cout of P1,125,000; a remaining useful lite at $ years and a far vitae of P400,0Q0. The only entry made at the date of the donation was the cnhy expensing P45,000, which 15 the fee paid to ers Tawipmend ue.0 (Pat Beal effect the transfer of ownership. Wf Wifey tea) a ery The company purchased a machine worth P403,000 on April 40, 2008. The company charged the purchase to expense. The machine has an estimated life of years, The company uses the straight fine method and the machine ha an estimated Ie of 3 years Ps 4 Les) tyy) The physical count of the merchandise A@ntory had tetn understated by P96,000 and by P66,750 at the end of 2009 and 2011, respectively, The merchandise inventories, which were in transit_at the end of 2010 and 2011 amounting to P51,000 and P48,900; respectively were not included in the physical and were not likewise recorded as purchases. These were purchased under FOB shipping point What is the correct accumulated profit as of December 31, 2008? a, 871,350 FF 186,350 b. 1,276,350 d, 1,141,350 What is the correct net income for the year ended December 31, 2009? a, $54,700 419,700 b. 323,700 d. 559,650 What is the correct accumulated profit balance as of December 31, 20102 4%. 721,500 . 811,500 b. 616,500 4. 361,500 What is the correct net loss for the year ended December 31, 2011? a. 177,450 © 222,50 ff 342,450 d. 267,450 ‘Accounting Policies - specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements {An entity shall change an accounting policy only if the change Applying Changes in Accounting Policies: {a)__ is required by a Standard, or {b) results in the financial statements providing reliable and more relevant information (a) _ Initial application of a Standard — apply the transitional provision of the Standard, if any (b) If there is no transitional provision, the new accounting policy should apply retrospectively (as if the new accounting policy had always been applied from the very start). This is done by restating the profit of the prior year that és presented in the financial statements and adjusting the opening or beginning balance of the retained earnings of the prior year presented in the financial statements,Need: The ReviewSchool of Accountancy Page 5 of 0 ‘Change in Accounting Eetimates — an adjustment of the carrying amount of an asset or a liability a5 a result af new information or new developments and are not therefore corrections of an error Accounting information Cannot alway’ be measured and reported precisely. Sometimes for the financial statements to be reported on timely basis for decision making, accounting data often must be based on estimates of future events, The financial statements incorporate these estimates, which are based on the host professional judgment given the information available at thal time. Ata later date, however, additional experience or new facts sometimes make it clear that the estimates need 10 be revised to reflect the existing business circumstances, When this happens, a change in accounting estimates happens. Examples of areas for which changes in accounting estimates are made Include the following: © Uncollectible receivables © Useful lives of deprettabl ase * Residual values for depreciable assets © Warranty obligations The effect of a change in accounting estimate shall be recognized prospectively by including it in the profit and loss, PROBLEM 5; TL Co decided on January 2, 2011, to effect the following changes in its accounting policies, * BAD FBT. Bad debt percentage {rom 2% to 10% of accounts receivables. TL Co's receivable balance at December 31, 2011 was P960,000, and the allowance for bad debt account has a debit balance of P7,000. Cehonge 4 Acory. Eof,) © DEPRECIATION. An equipment with a total life of 15 years and a PS0,000 residual ated using SYD, was purchased on January 1, 2001 for P1,150,000. As of January 2, 2011, a change is made to SL methad, and the revised remaining life as of the date of change is 10 years, Residual value remains at P50,000. value, depres Compute for the following: 1. The 201 learrying value of the accounts receivable Payzooo Frovep x if 2. The depreciation expense for the current year is. ($7S0-— 1nsevfieye «150 3, The carrying value of the equipment as of December 31, 2011 is: $79750~ PROBLEM 6; PC Co. decided to change its depreciation method for its computer hardware from Straight-line to sum of the years’ digits beginning January 1, 2011. The computer hardware has a 10% salvage value and an estimated useful life of § years. The following computer purchases were made hy PC Co. at the beginning of each year. eee w hy 2008 2s ime yuem <2ayo 2008 4 — 60,000 a oto. une e a 2009» $0,000 #¥ (GF, oy cee) pea eD 2010 | 40,000 Mut 21,4 Siow 2 mae Hie % Compute for the following: dread DpH Ho aera 4 10 1, The depreciation expense for 2010 and 2011: iRe@SA: The ReviewSchool of Accountancy Page 6 of 6 Gm bed, ai PROBLEM 7: H Co. has been using the FIFO method of inventory costing since it began ‘operations in 2009. In 2011 the company changed to the weighted average method. The following are the December 31 inventory balances under each method: FIFO Weighted Average * ‘eo 2en we 2009 500.000 565,000 Me, Be. 2010 450,000, 1 $0,000 loge’ (uo,a%) 2011 895,000 999,000. Rybynk 4 OCF aera The effect on retained earnings as a resuit of making, the change on January 1, 2011}. x 110,000 increase: cc 6,006 decrease 'b. 104,000 increase d- 2'4.000 increase jan ASE lou. verre ys tos, Wee he HE in He? a >