UNIT 1

ANALYSIS AND CORRECTION OF ERRORS

Discussion questions 1-1

1. What are the requirements of PSA 450 Evaluation of Misstatements Identified during the
Audit?
2. Define the following terms:
a. Reclassifying entry
b. Correcting entry
c. Adjusting entry
3. What do books still open and books already closed mean? What is the impact of each
on reclassifying, correcting, and adjusting entries?
4. What are prior period errors? Explain the treatment of prior period errors and provide two
examples.
5. Differentiate counterbalancing and non-counterbalancing errors. Provide two examples
each.

Problem 1-1 Errors in recognizing deferrals and accruals

Certain errors listed below were made by AAA Corporation. Indicate the effects of errors
on the companys financial statements by inserting in the space O, U, and NE to indicate
overstatement, understatement, and no effect, respectively.

Total
Revenue

Total
Expenses

Total Assets

Total
Liabilities

Owners
Equity

A
B
C
D
E
a.
b.
c.
d.
e.

Failed to record insurance costs incurred but not paid.

Failed to accrue interest on notes receivable.
Failed to adjust unearned revenue for portion earned during the year.
Failed to adjust supplies not used during the year.
Failed to accrue salaries for the last five days of the year.

Problem 1-2 Errors in recognizing property, plant, and equipment and the related
depreciation and bad debts
Pack Company's net incomes for the past three years are presented below:

2014
P480,000

2013
P450,000

2012
P360,000

During the 2014 year-end audit, the following items come to your attention:
1. Pack bought a truck on January 1, 2011 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)
2. During 2014, Pack changed from the straight-line method of depreciating its cement plant to
the double-declining balance method. The following computations present depreciation on
both bases:
2014
2013
2012
Straight-line
36,000
36,000
36,000
Double-declining 72,000
57,600
46,080
The net income for 2014 was computed using the double-declining balance method, on the
January 1, 2014 book value, over the useful life remaining at that time. The depreciation
recorded in 2014 was P72,000.
3. Pack, in reviewing its provision for uncollectibles during 2014, has determined that 1% is the
appropriate amount of bad debt expense to be charged to operations. The company had
used 1/2 of 1% as its rate in 2013 and 2014 when the expense had been P18,000 and
P12,000, respectively. The company recorded bad debt expense under the new rate for
2011. The company would have recorded P6,000 less of bad debt expense on December
31, 2014 under the old rate.

1. Prepare in general journal form the entry necessary to correct the books for the
transaction in item 1 of this problem, assuming that the books have not been closed
for the current year.
2. Compute the net income to be reported for the year 2012.
3. Compute the net income to be reported for the year 2013.
4. Compute the net income to be reported for the year 2014.
5. Assume that the beginning retained earnings balance (unadjusted) for 2012 was
P1,360,000. At what adjusted amount should this beginning retained earnings
balance for 2012 be stated, assuming that comparative financial statements were
prepared?
6. Assume that the beginning retained earnings balance (unadjusted) for 2014 is
P1,500,000 and that non-comparative financial statements are prepared. At what
adjusted amount should this beginning retained earnings balance be stated?
Problem 1-3 Analysis of various errors
The retained earnings account of Peter Pan Corporation is reproduced below:

Date
2012
Jan. 1
Dec. 31

Item

RETAINED EARNINGS
Debit

Balance
Net income for the year

Credit
P 78,000
18,000

2013
Jan. 10
Mar. 6
Dec. 31
2014
Jan. 9
Dec. 31

Dividends paid
Stock sold excess over par
Net loss for the year
Dividends paid
Balance

P 15,000
35,000
11,200
15,000
89,800
P 131,000

P 131,000

The audit of the Companys financial statements December 31, 2014 reveals the following:
a. Dividends declared on December 10, 2012 and 2013 had not been recorded in the books
until paid.
b. Improvements in buildings and equipment of P9,500 had been charged to expense at the
end of April 2011. Improvements are estimated to have an 8-year life. Peter Pan
Corporation computes depreciation to the nearest month and uses the straight-line
depreciation.
c. The physical inventory of merchandise had been understated by P3,000 at the end of 2012,
and by P4,300 at the end of 2013.
d. Merchandise in transit and to which the company had title at December 31, 2013 and 2014
was not included in the year-end inventories. These shipments of P3,500 and P5,800 were
recorded as purchases in January of 2014 and 2015, respectively.
e. The company had failed to record sales commissions payable of P2,000 and P1,500 at the
end of 2013 and 2014, respectively.
f. The company had failed to recognize supplies on hand of P1,200 and P2,500 at the end of
2013 and 2014, respectively.
g. The company reported a net loss of P18,500 for the year ended December 31, 2014.

1. Prepare the necessary adjusting journal entries at December 31, 2014.

2. What is the corrected net loss of Peter Pan Corporation for the year ended December
31, 2014?
Problem 1-4 Working paper preparation
You have been engaged to prepare corrected financial statement figures for DDD, Inc.
The records are in agreement with the following balance sheet:
DDD, Inc.
Balance Sheet
December 31, 2014
Assets
Cash
Accounts receivable
Notes receivable
Inventory

P110,000
110,000
130,000
240,000
P590,000

Liabilities and Equity

Accounts payable
P100,000
Notes payable
30,000
Ordinary shares
200,000
Retained earnings
260,000
P590,000

A review of the records of the company indicates that the errors and omissions listed in the table
that follows had not been corrected during the applicable years:

Dec 31
2011
2012
2013
2014

Inventory
overstated
P70,000
85,000
-

Inventory
understated
P65,000
95,000

Prepaid
expense
P9,000
8,000
7,000
6,000

Unearned
Revenue
P4,000
3,000

Accrued
Expenses
P2,000
650
1,000
600

The net income according to the records is P55,000, P85,000, and P60,000 for the years 2012,
2013, and 2014, respectively. No dividends were declared during these years and no
adjustments were made to retained earnings.

Prepare (1) a working paper to arrive at the corrected net income for the years 2012, 2013,
and 2014 and (2) a corrected balance sheet as of December 31, 2014.
Problem 1-5 Comprehensive problem
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
been audited before. It has prepared the following comparative financial statements for the
years ended December 31, 2014 and 2013.
CAPTAIN HOOK
COMPARATIVE STATEMENTS OF FINANCIAL POSITION
December 31, 2013 and 2012
Assets
Current assets:
Cash and cash equivalents
Accounts receivable
Allowance for bad debts
Inventory
Total current assets

P 1,205,000
1,960,000
(185,000)
1,035,000
P 4,015,000

P 800,000
1,480,000
(90,000)
1,010,000
P 3,200,000

Non-current assets:
Property, plant, and equipment
Accumulated depreciation
Total non-current assets
Total assets

835,000
(608,000)
227,000
P 4,242,000

847,500
(532,000)
315,500
P 3,515,500

P 607,000

P 980,500

1,300,000
2,335,000
3,635,000
P 4,242,000

1,300,000
1,235,000
2,535,000
P 3,515,500

Liabilities and Shareholders Equity

Liabilities:
Accounts payable
Shareholders equity:
Ordinary shares, P20 par value; 150,000 shares
authorized; 65,000 shares issued and outstanding
Retained earnings
Total shareholders equity
Total liabilities and shareholders equity

2013

2012

CAPTAIN HOOK
COMPARATIVE INCOME STATEMENTS
For the Years Ended December 31, 2012 and 2011
2013

The

Sales
Cost of goods sold
Gross income
Operating expenses:
Selling expenses
Administrative expenses
Total operating expenses
Net income

2012

P 5,320,000
2,150,000
P 3,170,000

P 4,500,000
1,975,000
P 2,525,000

1,150,000
600,000
1,750,000
P 1,420,000

1,025,000
565,000
1,590,000
P 935,000

2014 audit
revealed

the following facts:

a. On January 5, 2013, Captain Hook had charged a 5-year insurance premium to
expense. The premium totaled P31,000.
b. The amount of loss due to bad debts has steadily decreased over the last 2 years.
Captain Hook has decided to reduce the amount of bad debt expense from 2% to 1 %
of sales, beginning with 2014. (A charge of 2% has already been made for 2013).
c. Captain Hook uses the periodic inventory system. The following are the inventory errors
for the last 2 years.
2013 Ending inventory overstated by P75,000
2012 Ending inventory overstated by P99,500
d. An equipment costing P300,000 was acquired on January 3, 2013. The purchase was
recorded by a charge to operating expense. The equipment has a useful life of 10 years
and a residual value of P50,000. Captain Hook uses the straight-line method in
depreciating its assets.

1. Prepare the adjusting journal entries to correct the books at December 31, 2014.
Assume that the books for 2014 have not yet been closed.
2. What is Captain Hooks corrected net income for the year ended December 31, 2013?
3. What is Captain Hooks corrected net income for the year ended December 31, 2014?