Auditing Practice I Third Term, AY 2013-2014

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UNIT1
ANALYSISANDCORRECTIONOFERRORS
EstimatedTime:2.5HOURS

Discussionquestions1-1
1. Definethefollowingterms:
a. Reclassifyingentry
b. Correctingentry
c. Adjustingentry
2. Whatdobooksstillopenandbooksalreadyclosedmean?Whatistheimpactof
eachonreclassifying,correcting,andadjustingentries?
3. Whatarepriorperioderrors?Explainthetreatmentofpriorperioderrorsandprovide
twoexamples.
4. Differentiate counterbalancing and non-counterbalancing errors. Provide two
exampleseach.

Problem1-1Errorsinrecognizingdeferralsandaccruals
CertainerrorslistedbelowweremadebyAAACorporation.Indicatetheeffectsoferrors
onthecompanysfinancialstatementsbyinsertinginthespaceO,U,andNEtoindicate
overstatement,understatement,andnoeffect,respectively.

Total
Revenue
Total
expenses
Total
assets
Total
Liabilities
Owners
Equity
A
B
C
D
E

a. Failedtorecordinsurancecostsincurredbutnotpaid.
b. Failedtoaccrueinterestonnotesreceivable.
c. Failedtoadjustunearnedrevenueforportionearnedduringtheyear.
d. Failedtoadjustsuppliesnotusedduringtheyear.
e. Failedtoaccruesalariesforthelastfivedaysoftheyear.

Problem 1-2 Errors in recognizing property, plant, and equipment and the related
depreciationandbaddebts

PackCompany'snetincomesforthepastthreeyearsarepresentedbelow:
2012 2011 2010
P480,000 P450,000 P360,000

Duringthe2012year-endaudit,thefollowingitemscometoyourattention:

1. Pack bought a truck on January 1, 2009 for P196,000 with a P16,000 estimated
salvage value and a six-year life. The company debited an expense account and
credited cash on the purchase date for the entire cost of the asset. (Straight-line
method)

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2. During2012,Packchangedfromthestraight-linemethodofdepreciatingitscement
plant to the double-declining balance method. The following computations present
depreciationonbothbases:
2012 2011 2010
Straight-line 36,000 36,000 36,000
Double-declining 72,000 57,600 46,080

Thenetincomefor2012wascomputedusingthedouble-decliningbalancemethod,
on the January 1, 2012 book value, over the useful life remaining at that time. The
depreciationrecordedin2012wasP72,000.

3. Pack, in reviewing its provision for uncollectibles during 2012, has determined that
1%istheappropriateamountofbaddebtexpensetobechargedtooperations.The
company had used 1/2 of 1% as its rate in 2011 and 2012 when the expense had
beenP18,000andP12,000,respectively.Thecompanyrecordedbaddebtexpense
underthenewratefor2009.ThecompanywouldhaverecordedP6,000lessofbad
debtexpenseonDecember31,2012undertheoldrate.

1. Prepare in general journal form the entry necessary to correct the books for the
transactioninitem1ofthisproblem,assumingthatthebookshavenotbeenclosed
forthecurrentyear.
2. Computethenetincometobereportedfortheyear2010.
3. Computethenetincometobereportedfortheyear2011.
4. Computethenetincometobereportedfortheyear2012.
5. Assume that the beginning retained earnings balance (unadjusted) for 2010 was
P1,360,000. At what adjusted amount should this beginning retained earnings
balance for 2010 be stated, assuming that comparative financial statements were
prepared?
6. Assume that the beginning retained earnings balance (unadjusted) for 2012 is
P1,500,000 and that non-comparative financial statements are prepared. At what
adjustedamountshouldthisbeginningretainedearningsbalancebestated?

Problem1-3Analysisofvariouserrors
TheretainedearningsaccountofPeterPanCorporationisreproducedbelow:

RETAINEDEARNINGS
Date Item Debit Credit
2010
Jan.1 Balance P78,000
Dec.31 Netincomefortheyear 18,000
2011
Jan.10 Dividendspaid P15,000
Mar.6 Stocksoldexcessoverpar 35,000
Dec.31 Netlossfortheyear 11,200
2012
Jan.9 Dividendspaid 15,000
Dec.31 Balance 89,800
P131,000 P131,000

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The audit of the Companys financial statements December 31, 2012 reveals the
following:

a. Dividends declared on December 10, 2010 and 2011 had not been recorded in the
booksuntilpaid.

b. ImprovementsinbuildingsandequipmentofP9,500hadbeenchargedtoexpenseat
theendofApril2009.Improvementsareestimatedtohavean8-yearlife.PeterPan
Corporation computes depreciation to the nearest month and uses the straight-line
depreciation.

c. ThephysicalinventoryofmerchandisehadbeenunderstatedbyP3,000attheendof
2010,andbyP4,300attheendof2011.

d. MerchandiseintransitandtowhichthecompanyhadtitleatDecember31,2011and
2012 was not included in the year-end inventories. These shipments of P3,500 and
P5,800wererecordedaspurchasesinJanuaryof2012and2013,respectively.

e. ThecompanyhadfailedtorecordsalescommissionspayableofP2,000andP1,500
attheendof2011and2012,respectively.

f. The company had failed to recognize supplies on hand ofP1,200 and P2,500 at the
endof2011and2012,respectively.

g. ThecompanyreportedanetlossofP18,500fortheyearendedDecember31,2012.

1. PreparethenecessaryadjustingjournalentriesatDecember31,2012.
2. What is the corrected net loss of Peter Pan Corporation for the year ended
December31,2012?

Problem1-4Workingpaperpreparation
You have been engaged to prepare corrected financial statement figures for DDD, Inc.
Therecordsareinagreementwiththefollowingbalancesheet:

DDD,Inc.
BalanceSheet
December31,2012
Assets LiabilitiesandEquity
Cash P110,000 Accountspayable P100,000
Accountsreceivable 110,000 Notespayable 30,000
Notesreceivable 130,000 Ordinaryshares 200,000
Inventory 240,000 Retainedearnings 260,000
P590,000 P590,000

Areviewoftherecordsofthecompanyindicatesthattheerrorsandomissionslistedin
thetablethatfollowshadnotbeencorrectedduringtheapplicableyears:

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Dec.31 Inventory
overstated
Inventory
understated
Prepaid
expense
Unearned
revenue
Accrued
expenses
2009 - P65,000 P9,000 - P2,000
2010 P70,000 - 8,000 P4,000 650
2011 85,000 - 7,000 - 1,000
2012 - 95,000 6,000 3,000 600

ThenetincomeaccordingtotherecordsisP55,000,P85,000,andP60,000fortheyears
2010,2011,and2012,respectively.Nodividendsweredeclaredduringtheseyearsand
noadjustmentsweremadetoretainedearnings.

Prepare (1) a working paper to arrive at the corrected net income for the years 2010,
2011,and2012and(2)acorrectedbalancesheetasofDecember31,2012.

Problem1-5Comprehensiveproblem
Captain Hook is in the process of obtaining a loan at Tinker Bell Bank. The bank has
requested audited financial statements. Captain Hooks financial statements have never
beenauditedbefore.Ithaspreparedthefollowingcomparativefinancialstatementsforthe
yearsendedDecember31,2012and2011.

CAPTAINHOOK
COMPARATIVESTATEMENTSOFFINANCIALPOSITION
December31,2012and2011

Assets

2012

2011

Currentassets:
Cashandcashequivalents P1,205,000 P800,000
Accountsreceivable 1,960,000 1,480,000
Allowanceforbaddebts (185,000) (90,000)
Inventory 1,035,000 1,010,000
Totalcurrentassets P4,015,000 P3,200,000

Non-currentassets:
Property,plant,andequipment 835,000 847,500
Accumulateddepreciation (608,000) (532,000)
Totalnon-currentassets 227,000 315,500
Totalassets P4,242,000 P3,515,500

LiabilitiesandShareholdersEquity

Liabilities:
Accountspayable P607,000 P980,500
Shareholdersequity:
Ordinaryshares,P20parvalue;150,000shares
authorized;65,000sharesissuedandoutstanding 1,300,000 1,300,000
Retainedearnings 2,335,000 1,235,000
Totalshareholdersequity 3,635,000 2,535,000
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Totalliabilitiesandshareholdersequity P4,242,000 P3,515,500

CAPTAINHOOK
COMPARATIVEINCOMESTATEMENTS
FortheYearsEndedDecember31,2012and2011

2012 2011

Sales P5,320,000 P4,500,000

Costofgoodssold 2,150,000 1,975,000
Grossincome P3,170,000 P2,525,000
Operatingexpenses:
Sellingexpenses 1,150,000 1,025,000
Administrativeexpenses 600,000 565,000
Totaloperatingexpenses 1,750,000 1,590,000
Netincome P1,420,000 P935,000

The2012auditrevealedthefollowingfacts:

a. On January 5, 2011, Captain Hook had charged a 5-year insurance premium to

expense.ThepremiumtotaledP31,000.

b. The amount of loss due to bad debts has steadily decreased over the last 2 years.
CaptainHookhasdecidedtoreducetheamountofbaddebtexpensefrom2%to1
% of sales, beginning with 2012. (A charge of 2% has already been made for
2011).

c. Captain Hook uses the periodic inventory system. The following are the inventory
errorsforthelast2years.
2011EndinginventoryoverstatedbyP75,000
2012EndinginventoryoverstatedbyP99,500

d. An equipment costing P300,000 was acquired on January 3, 2011. The purchase

wasrecordedbyachargetooperatingexpense.Theequipmenthasausefullifeof
10 years and a residual value of P50,000. Captain Hook uses the straight-line
methodindepreciatingitsassets.

1. Prepare the adjusting journal entries to correct the books at December 31, 2012.
Assumethatthebooksfor2012havenotyetbeenclosed.
2. What is Captain Hooks corrected net income for the year ended December 31,
2011?
3. What is Captain Hooks corrected net income for the year ended December 31,
2012?