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CHAPTER

19
19-1.

COMPREHENSIVE AUDIT OF
BALANCE SHEET AND INCOME
STATEMENT ACCOUNTS

Daffodil, Inc.
Adjusting Journal Entries
12.31.07
AJE (1)

(2)

Share donation
Treasury shares
Land
Building

35,000
10,000
15,000

Accumulated depreciation - machinery


Loss on sale of machinery
Machinery
Cost
Less: AD (20%)
NBV
Proceeds
Loss

(3)

60,000

(b) Factory operating expenses


Accumulated depreciation - building
Accumulated depreciation - machinery

(4)

(5)

300
300
21,300
6,300
15,000

P 500
14,500
P15,000

Merchandise inventory, 12.31.07 B/S


Merchandise inventory, 12.31.07 I/S
Administrative expenses

3,000

P 5,000
1,000
P 4,000
2,000
P 2,000

(a) Accumulated depreciation - building


Retained earnings

Building (P315,000 x 2%)


Machinery:
5,000 x 10% =
145,000 x 10% =

1,000
2,000

175,000
175,000
1,000

19-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition


Allowance for doubtful accounts
(6)
(7)

(8)
(9)

1,000

Factory operating expenses


Unexpired insurance

3,000

Retained earnings
Bond interest expense
Unamortized bond discount

2,500
2,500

Sinking fund assets


First Mortgage SF Bonds
Sinking fund assets
Sinking fund income

3,000

5,000
23,500
23,500
1,500
1,500

Comprehensive Audit of Balance Sheet and Income Statement Accounts


19-1.

19-3

Daffodil, Inc. (continued)


Daffodil, Inc.
Working Trial Balance
12.31.07

Cash
Accounts receivable
Provision for doubtful accounts
Inventories, 12.31.06
Unexpired insurance, 12.31.06
Land
Buildings
Accumulated Depreciation - Buildings
Machinery
Accumulated Depreciation - Machinery
Sinking fund assets
Unamortized bond discount
Treasury shares, ordinary
Accounts payable
Bond interest accrued
1st Mortgage, 6% SF Bonds
Ordinary shares
Premium on ordinary shares
Share donation
Retained earnings, 12.31.06
Sales
Purchases
Payroll
Factory operating expenses

Trial Balance
Dr
Cr
P 64,000
200,000
P 1,000
223,000
6,000
220,000
330,000
6,600
148,000
15,000
25,000

Adjustments
Dr

283,500
169,000
121,500

(3a)
(2)
(8)
(9)

300
1,000
23,500
1,500

(1)
(7)

60,000
2,500

35,000

Bond interest expense

15,000

(7)

2,500

(2)
(4)

2,000
175,000

3,000
10,000
15,000
6,300
3,000
15,000

(7)
(1)

5,000
35,000

(8)

23,500

(3a)

3,000
210,000
315,000
12,600
145,000
29,000
50,000
20,000
88,000
3,750
250,000
500,000
50,000
71,950

300

21,300
3,000
1,000

145,800
36,000
17,500

P1,900,000

P 293,600
Net Income

(6)
(1)
(1)
(3b)
(2)
(3b)

P 875,000

Administrative expenses

P1,900,000

1,000

283,500
169,000
(3b)
(6)
(5)

Loss on sale of machinery


Merchandise inventory 12.31.07
Sinking fund income

(5)

Balance Sheet
Dr
Cr
P 64,000
200,000
P 2,000

P 223,000

25,000
35,000
88,000
3,750
226,500
500,000
50,000
60,000
74,150
875,000

Income Statement
Dr
Cr

Cr

2,000
(4)
(9)

175,000
1,500
P 293,600

175,000
1,500

175,000

P 876,800
174,700

P1,051,500

P1,182,000

P1,007,300
174,700

P1,051,500

P1,051,500

P1,182,000

P1,182,000

19-4

Solutions Manual to Accompany Applied Auditing, 2002 Edition

19-2.
Part I

Adjusting Journal Entries, 12-31-05

AJE (1)

Depreciation expense
Accumulated depreciation

1,778
1,778

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


9
(2)

(3)

(4)
(5)
(6)

(7)

(8)
(9)

Prepaid interest
Retained earnings
Interest expense
Merchandise inventory, 12-31-07, BS
Merchandise inventory, 12-31-07, IS or
Cost of Sales

3,100
1,900
15,000
15,000

Retained Earnings
Purchases

6,000

Prepaid insurance
Insurance expense

3,000

Store supplies inventory


Store supplies expense
Retained earnings

1,450

6,000
3,000
550
900

Retained earnings
Commissions expense
Accrued commissions payable

730
240

Cash in bank
Miscellaneous income

650

Purchases
Accounts payable

800

(10) Income from Investment


Investment
(11) Prepaid advertising and promotions
Advertising and promotions expense
(12)

5,000

970
650
800
3,000
3,000
90,000
90,000

NO AJE

(13) Machinery
Depreciation expense machinery
Allowance for depreciation machinery
Repairs and maintenance

20,000
167
167
20,000

Comprehensive Audit of Balance Sheet and Income Statement Accounts


(14) Miscellaneous income
Gain on sale of treasury shares
Land
Additional paid-in capital arising from
Treasury Share transactions

2,000
5,000

(15) Doubtful accounts expense


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 Allowance
account
Additional Provision

19-5

2,000
5,000
14,500
P 1,500
4,000
P 5,500
9,000
P14,500

Part II Column B Adjustment, 12-31-07


AJE (a)

Retained earnings
Purchases

xx

(b)

NONE

xx

(c)

Retained Earnings
Allowance for depreciation

xx

Retained Earnings
Allowance for depreciation

xx

Machinery
Retained earnings

xx

Depreciation
Allowance for depreciation

xx

Retained earnings
Taxes

xx

xx
xx

(d)
(e)
(f)
(g)
19-3.

xx
xx
xx
xx
xx

International Company
AJE (1)
(2)

Depreciation expense
Accumulated depreciation delivery vehicle
Cost of sales
Retained earnings

3,200
3,200
19,000
19,000

19-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition


(3)
(4)
(5)

(6)
(7)
(8)
(9)

Cost of sales
Inventory

8,500

Cash
Accounts receivable

5,600

Accumulated depreciation equipment


Equipment
Gain on sale of equipment
Estimated litigation loss
Estimated litigation liability

8,500
5,600
22,000
18,300
3,700
125,000
125,000

Unrealized holding gain or loss Income


Allowance for decline in value of securities

2,000

Accrued salaries payable


Salaries expense

3,800

Depreciation expense
Equipment
Repairs expense
Accumulated depreciation equipment

(10) Insurance expense


Prepaid insurance
Retained earnings

2,000
3,800
4,000
32,000
32,000
4,000
5,000
7,000
12,500

(11) No adjusting entry. Trademark has indefinite


life and no amortization need be made.
19-4.

Sunshine Cosmetics, Inc.


Requirement (1)
AJE (1)

(2)

(3)

Inventory, Dec. 31, 2006 (BS)


Inventory, Dec. 31, 2006 (IS) or
Cost of sales

67,200

Doubtful accounts expense


Allowance for doubtful accounts
(15,660 740)

14,920

Accounts payable
Purchase returns and allowances

20,760

67,200

14,920
20,760

Comprehensive Audit of Balance Sheet and Income Statement Accounts


(4)
(5)
(6)
(7)
(8)
(9)

Sales commissions
Accrued commissions payable

19-7

216
216

Freight-in
Accounts payable

1,600

Advertising expense
Prepaid advertising

1,212

Freight-out or Expense
Sales

8,400

Interest receivable
Interest income

1,380

Depreciation expense
Accumulated depreciation

1,300

1,600
1,212
8,400
1,380
1,300

(10) Supplies expense


Unused Supplies

1,160
1,160

(11) Provision for Income tax expense


Income tax payable

107,386
107,386

Requirement (2)
Sunshine Cosmetics, Inc.
Income Statement
For the Year Ended December 31, 2006
Revenue from sales:
Sales
Less: Sales returns and
and allowances
Sales discounts
Cost of goods sold:
Inventory, January 1
Net purchases:
Purchases
Less purchase returns
and allowances
Freight-in
Cost of goods available
for sale
Less Inventory, December 31
Gross profit on sales

P998,800 (a)
P 22,400
1,760

24,160

P974,640

P179,400
P346,000
20,760 (c)

325,240
12,650 (b)
P517,290
108,300 (d)

408,990
P565,650

19-8

Solutions Manual to Accompany Applied Auditing, 2006 Edition


Other income:
Interest revenue
Dividend revenue
Gain on sale of assets
Total income
Operating expenses:
Selling expenses:
Sales salaries and
commissions
Advertising expense
Depreciation expense
Sales/delivery equipment
Freight expense
Travel expense sales
representatives
Miscellaneous selling
expenses
General and administrative
expenses:
Legal services
Insurance and licenses
Depreciation expense
office equipment
Utilities
Telephone and postage
Supplies expense
Officers salaries
Doubtful accounts expense
Total operating expenses
Other expense and losses:
Interest expense
Loss on sale of equipment
Income from continuing
operations before income taxes
Income taxes
Income from continuing
operations
Discontinued operations:
Gain from discontinued
operations (net of income
taxes of P25,600)
Net income

P 2,780 (i)
14,300
37,000

54,080
P619,730

P 70,216 (e)
33,392 (f)
13,500 (g)
8,400
9,120
4,400

P139,028

P 4,450
17,000
9,600
12,800
2,950
1,160 (k)
73,200
14,920 (h)

136,080
(275,108)
P 9,040
45,200

(54,240)
P290,382
92,922 (j)
P197,460

54,400
P251,860

Comprehensive Audit of Balance Sheet and Income Statement Accounts


Earnings per ordinary share:
Income from continuing operations (P197,460 78,000 shares)
Gain from discontinued operations (P54,400 78,000 shares)
Net income (P251,860 78,000 shares)

19-9

P2.53
0.70
P3.23

Computations:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)

Sales: P990,400 + P8,400 = P998,800


Freight-in: P11,050 + P1,600 = P12,650
Purchase returns and allowances: P346,000 x 6% = P20,760
Inventory: P41,100 + P67,200 = P108,300
Sales salaries and commissions: P70,000 + (P7,200 x 3%) = P70,216
Advertising expense: P32,180 + (P3,636 x 2/6) = P33,392
Depreciation expense: P12,200 + (P15,600 x 10/120) = P13,500
Doubtful accounts expense: (P522,000 x 3%) P740 = P14,920
Interest revenue: P1,400 + P1,380 = P2,780
Income taxes: P335,582 x 32% = P107,387
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


Add net income per income statement

P 881,340
251,860
P1,133,200
66,000
P1,067,200

Deduct dividends paid


Retained earnings, December 31
19-5.

Del Bakery
Working papers are not required, but they facilitate the preparation of a corrected
balance sheet.
Del Bakery
Working Papers for Corrected Balance Sheet
December 31, 2007
Account Title
Current Assets......................
Current Liabilities.................
Other Assets.........................
Other Liabilities....................
Investment in Business........

Balance Sheet
Debit
Credit
53,415
..............
..............
29,000
75,120
..............
..............
3,600
..............
95,935
128,535
128,535

Corrections
Debit
Credit
..............
(a) 53,415
(c) 29,000
..............
..............
(b) 75,120
(d) 3,600
..............
(e) 95,935
..............
..............
..............

Corrected Balance Sheet


Debit
Credit
..............
..............
..............
..............
..............
..............
..............
..............
..............
..............
..............
..............

19-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition


Cash.....................................
Investment Securities
trading (at market value)....
Trade Accounts Receivable.
Inventory...............................
Supplies Inventory................
Delivery Truck......................
Fixtures.................................
Accumulated Depreciation
Fixtures...............................
Cash Surrender Value of
Insurance on Officers
Lives...................................
Retained Earnings................

Land.....................................
Buildings...............................
Accumulated Depreciation
Buildings [2 (P62,000
20)]
11% Mortgage Payable........
11% Mortgage Payable
(current portion)..................
Interest Payable...................
Trade Accounts Payable......
Miscellaneous Liabilities......
Share Capital, P5 stated
value, 5,000 shares............
Paid-in Capital from Sale of
Shares at More Than
Stated Value.......................

Corrections:

(a)
(b)
(c)

..............

..............

(a) 10,600

..............

10,600

..............

..............
..............
..............
..............
..............
..............

..............
..............
..............
..............
..............
..............

(a)
(a)
(a)
(a)
(a)
(a)

..............
..............
..............
..............
..............
..............

2,575
12,500
8,040
425
2,100
12,500

..............
..............
..............
..............
..............
..............

..............

..............

..............

(a) 2,100

..............

2,100

..............
..............
..............
..............

..............
..............
..............
..............

(a) 4,100
(a) 2,675
(b) 7,750
(d)
350

..............
..............
..............
..............

4,100
..............
..............
..............

..............
..............
..............
30,160

..............
..............
..............

..............
..............
..............

..............
(b) 30,000
(b) 62,000

(e) 40,935
..............
..............

..............
30,000
62,000

..............
..............
..............

..............
..............

..............
..............

..............
..............

(b) 7,750
(b) 12,000

..............
..............

7,750
12,000

..............
..............
..............
..............

..............
..............
..............
..............

..............
..............
..............
..............

(b) 4,000
(b)
880
(c) 29,000
(d) 3,950

..............
..............
..............
..............

4,000
880
29,000
3,950

..............

..............

..............

(e) 25,000

..............

25,000

..............

..............

..............
284,150

(e) 30,000
284,150

..............
144,840

30,000
144,840

To restate current assets


To restate other assets
To restate current liabilities

2,575
12,500
8,040
425
2,100
12,500

(d)
(e)

To restate other liabilities


To restate owners equity accounts

Del Bakery
Corrected Balance Sheet
December 31, 2007
Assets
Current assets:
Cash.........................................................................

P10,600

Investment securities trading (reported at


market; cost P4,250)..........................................
Trade accounts receivable (fully collectible)..........
Inventory.................................................................
Supplies inventory...................................................

2,575
12,500
8,040
425

P 34,140

Comprehensive Audit of Balance Sheet and Income Statement Accounts

Investments:
Cash surrender value of life insurance....................
Land, buildings and equipment:
Land........................................................................
Buildings.................................................. P62,000
Less accumulated depreciation........... 7,750
Fixtures..................................................... P12,500
Less accumulated depreciation........... 2,100
Delivery truck.........................................................
Total assets....................................................................
Liabilities
Current liabilities:
Mortgage payable, portion due this year.................
Accounts payable....................................................
Interest payable.......................................................
Miscellaneous accrued liabilities............................
11% Mortgage payable (noncurrent portion)................
Total liabilities..............................................................
Owners Equity
Contributed capital:
Share capital, P5 stated value,
5,000 shares........................................ P25,000
Paid-in capital from sale of
ordinary shares at more than
stated value......................................... 30,000
Retained earnings..........................................................
Total owners equity......................................................
Total liabilities and owners equity...............................
19-6.

19-11

4,100
P30,000
54,250
10,400
2,100

P 4,000
29,000
880
3,950

96,750
P134,990

P 37,830
12,000
P 49,830

P55,000
30,160
85,160
P134,990

Masipag Corporation
Adjusting Journal Entries, Dec. 31, 2007
AJE (1)
(2)
(3)

Cash
Accounts payable
Accounts receivable
Cash
Bank loan payable

200,000
200,000
10,000
10,000
400,000

19-12

Solutions Manual to Accompany Applied Auditing, 2006 Edition

(4)
(5)
(6)
(7)

(8)
(9)

Other expenses
Cash

12,500

Cash
Accounts receivable

75,000

412,500

75,000

Operating expenses
Cash

1,500

Cash
Other income

16,000

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


Operating expenses
Cash

1,500
16,000
5,000
2,000
7,000

Marketable securities
Other income

40,000

Other income
Marketable securities

54,000

(10) Marketable securities


Other income
(10.a) Valuation allowance Marketable securities
Trading
Other income Unrealized holding gain

40,000
54,000
32,000
32,000
145,600
145,600

(11) Sales
Accounts receivable

500,000

(12) Inventory
Cost of sales

400,000

500,000
400,000

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


Accounts receivable

15,000

(14) Accounts receivable others


Accounts receivable

55,000

(15) Accounts receivable


Other current liabilities

50,000

(16) Operating expenses


Allowance for doubtful accounts

21,900

(17) Other income

54,545

15,000
55,000
50,000
21,900

Comprehensive Audit of Balance Sheet and Income Statement Accounts


Discount on notes receivable
(18) Discount on notes receivable
Other income

19-13
54,545

4,545
4,545

(19) Cost of sales


Accounts payable

60,000

(20) Cost of sales


Accounts payable

25,000

(21) Inventory
Cost of sales

25,000

(22) Accounts receivable others


Inventory

16,000

(23) Sales
Accounts receivable

13,000

(24) Operating expenses


Prepaid expenses

46,250

(25) Operating expenses


Prepaid expenses

5,000

(26) Other assets


Operating expense
Prepaid expenses

60,000
120,000

60,000
25,000
25,000
16,000
13,000
46,250
5,000

180,000

(27) Long-term bond investment


Other income

5,777

(28) Accounts receivable others


Other income

5,333

5,777
5,333

(29) Land
Building
Land and building

1,062,500
3,187,500

(30) Building
Land and building

425,000

(31) Operating expenses


Land and building

20,000

4,250,000
425,000
20,000

19-14

Solutions Manual to Accompany Applied Auditing, 2006 Edition


(32) Operating expenses
Prepaid expenses
Land and building

27,500
27,500
55,000

(33) Land and building


Operating expenses
Accumulated depreciation building

237,500
115,578
121,922

(34) Prepaid expenses


Operating expenses
Equipment

10,000
10,000

(35) Operating expenses


Accumulated depreciation equipment

55,400

(36) Accounts payable


Other current liabilities

50,000

(37) Operating expenses


Estimated liability on warranties

15,000

(38) Other current liabilities


Other expenses

50,000

20,000
55,400
50,000
15,000
50,000

(39) Income taxes payable


Provision for income tax

115,290
115,290

MASIPAG CORPORATION
Balance Sheet
December 31, 2007
Assets
Current assets
Cash
Marketable securities
Valuation allowance
Accounts receivable
Allowance for doubtful accounts
Notes receivable
Discount on notes receivable
Accounts receivable others
Inventory, December 31, 2007
Prepaid expenses
Total current assets
Investments

P
P 400,000
145,600
P 442,000
(33,150)
P 600,000
(50,000)

734,000
545,600
408,850
550,000
96,333
1,960,500
175,250
P4,470,533

Comprehensive Audit of Balance Sheet and Income Statement Accounts


Long-term bond investment
Property, plant and equipment
Land
Building
Accumulated depreciation Building

Equipment
Accumulated depreciation Equipment

19-15
744,077

P1,062,500
P3,612,500
(121,922)

3,490,578

P1,654,000
(235,400)

1,418,600

Total property, plant and equipment


Other assets
Total assets

5,971,678
110,000
P11,296,288

Liabilities and Shareholders Equity


Current liabilities
Accounts payable
Bank loan payable
Accrued expenses payable
Other current liabilities
Income taxes payable
Estimated liability on warranties
Total current liabilities
Shareholders equity
Ordinary shares
Additional paid-in capital
Retained Earnings
Total shareholders equity
Total liabilities and shareholders equity

P 877,000
1,100,000
59,000
100,000
130,558
70,000
P 2,336,558
P5,000,000
1,655,250
2,304,480
8,959,730
P11,296,288

MASIPAG CORPORATION
Income Statement
For the Year Ended December 31, 2007
Sales
Cost of sales
Gross profit
Other income
Operating expenses
Other expenses
Income before taxes
Provision for income tax
Net Income

19-7.

Felicity Company
Adjusting Journal Entries, Dec. 31, 2007

P 6,437,000
(4,060,000)
P 2,377,000
225,710
(1,511,509)
(37,500)
P 1,053,701
(342,441)
P 711,260

19-16

Solutions Manual to Accompany Applied Auditing, 2006 Edition


AJE (1)

Cash

31,000

Comprehensive Audit of Balance Sheet and Income Statement Accounts

(2)
(3)

(4)

(5)
(6)
(7)
(8)
(9)

Prepaid interest
Other charges
Long-term debt (current portion)
Long-term debt

3,000
2,000

Cash
Accounts payable and others

2,000

24,000
12,000
2,000

Investments in SMC shares available for sale


(non-current)
Marketable securities

72,000

Unrealized loss due to decline in value of


non-current investment (equity)
Operating expenses

20,000

Allowance for doubtful accounts


Operating expenses
Accounts receivable
Operating expenses

72,000

20,000
41,100
41,100
8,000
8,000

Inventory
Cost of sales

12,000

Sales
Accounts receivable

14,400

Revaluation increment
Accumulated depreciation
Property and equipment

19-17

12,000
14,400
120,000
80,000
200,000

(10) Accumulated depreciation


Operating expenses

36,000

(11) Operating expenses


Accumulated depreciation

48,000

(12) Revaluation increment


Retained earnings

24,000

(13) Property and equipment


Operating expenses

30,000

(14) Retained earnings


Cumulative effect of change in accounting

13,000

36,000
48,000
24,000
30,000
13,000

19-18

Solutions Manual to Accompany Applied Auditing, 2006 Edition


principle
(15) Accounts receivable others
Cash

22,000

(16) Provision for income tax


Income tax payable

25,445

22,000
25,445

FELICITY COMPANY
Balance Sheet
December 31, 2007
Assets
Current Assets:
Cash............................................................................................
Accounts receivable....................................................................
Allowance for doubtful accounts................................................
Accounts receivable -others........................................................
Inventories..................................................................................
Prepaid interest...........................................................................
Non-current Assets:
Advances to affiliate...................................................................
Investments in SMC shares available for sale.........................
Allowance for decline in value of non-current investment........
Property and equipment..............................................................
Accumulated depreciation..........................................................
(1,172,000)
Total Assets

123,600
1,751,820
(27,000)
62,000
262,000
3,000
48,000
72,000
(20,000)
2,600,000

P 3,703,420

Liabilities and Shareholders Equity


Accounts payable and others (including current portion of
bank loan of P24,000) ................................................................
Income tax payable............................................................................
Long-term debt...................................................................................
Ordinary share capital........................................................................
Retained earnings...............................................................................
Unrealized loss due to decline in value of investment in SMC.........
Revaluation increment.......................................................................
Total Liabilities and Shareholders Equity
FELICITY COMPANY
Income Statement
For the Year Ended December 31, 2007

434,616
100,205
72,000
2,042,000
978,599
(20,000)
96,000
P 3,703,420

Comprehensive Audit of Balance Sheet and Income Statement Accounts


Sales...................................................................................................
Cost of sales.......................................................................................
Gross profit........................................................................................
Operating expenses............................................................................
Other charges.....................................................................................
Income from continuing operations before tax..................................
Provision for income tax (35%).........................................................
Income from continuing operations after tax.....................................
Discontinued operations (net)............................................................
(6,500)
Net income.........................................................................................
19-8.

19-19

P 2,757,124
2,257,604
P 499,520
(83,522)
(102,000
P 313,998
109,899
P 204,099
P

197,599

Learn Company
Condensed Comparative Income Statements

Construction revenue
Construction expense
Other expenses
Income before income taxes
Income tax expense
Net income

2009
P900,000
(420,000)
(80,000)
P400,000
(120,000)
P280,000

2008
P420,000
(182,000)
(70,000)
P168,000
(50,400)
P117,600

2007
P200,000
(80,000)
(50,000)
P 70,000
(21,000)
P 49,000

Comparative Statements of Retained Earnings


Balance at beginning of year,
as previously reported
Add: Adjustment for the
cumulative effect on prior years
of applying retroactively the
new method of accounting for
long-term contracts (net of
income taxes)
Balance at beginning of year,
as adjusted
Net income
Balance at end of year

2009

2008

P 77,000

P 7,000

89,600

42,000

2007
P

P166,600

P 49,000

280,000

117,600

49,000

P446,600

P166,600

P 49,000

19-20

Solutions Manual to Accompany Applied Auditing, 2006 Edition


Note: The company has accounted for revenue and costs for long-term
construction contracts by the percentage-of-completion method in 2009, whereas
in prior years revenues and costs were determined by the completed-contract
method. The new method of accounting for long-term contracts was adopted to
(state justification for change in accounting principle) and financial statements of
prior years have been restated to apply the new method retroactively. The effect
of the accounting change on income of 2009 and on income as previously reported
in 2007 and 2008 is as follows:

Net income
Earnings per ordinary share

2009
P112,000
P11.20

Increase
2008
P47,600
P4.76

2007
P42,000
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 P7,000

(P49,000 + P117,600) (P7,000 + P70,000)

19-9.

P280,000 [(P600,000 P280,000 P80,000) x (1 0.30)]

Goody Construction Company


Requirement (1)
2007
Jan. 1

Construction in Progress
Retained Earnings [P70,000 x (1 0.30)]
Deferred Tax Asset
a
[(P100,000 + P120,000) + (P125,000 +
P75,000)] (P100,000 + P250,000)

70,000 a
49,000
21,000

Requirement (2)
GOODY CONSTRUCTION COMPANY
Condensed Comparative Income Statements (Partial)
Income before income taxes
Income taxes at 30%
Net income
Earnings per ordinary share
(100,000 shares)

2007
P400,000
(120,000)
P280,000
P2.80

2006
P200,000
(60,000)
P140,000
P1.40

2005
P220,000
(66,000)
P154,000
P1.54

19-21

Comprehensive Audit of Balance Sheet and Income Statement Accounts

Comparative Statements of Retained Earnings


2007
Balance at beginning of year,
as previously reported
Add: Adjustment for the
cumulative effect on prior years
of applying retroactively
applying the new method of
accounting for long-term
contracts (net of income taxes)
Balance at beginning of year,
as adjusted
Net income
Balance at end of year
b

P100,000 x (1 0.30)

P250,000 x (1 0.30) + P70,000

2006

2005

P245,000

P 70,000

49,000

84,000

P294,000
280,000
P574,000

P154,000
140,000
P294,000

0
P
0
154,000
P154,000

[(P100,000 + P120,000) P100,000] x (1 0.30)

[(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, whereas
in 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 of
prior 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:

Net income
Earnings per ordinary share

2007
P(49,000)
P(0.49)

Increase
2006
P(35,000)
P(0.35)

2005
P84,000
P0.84

19-22

Solutions Manual to Accompany Applied Auditing, 2006 Edition


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)

(P200,000 P250,000) x (1 0.30)

[P400,000 (P820,000 P350,000)] x (1 0.30)


Items Restated:
On the 2005 and 2006 income statements, construction revenues and expenses
would 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
Notes Payable
Depreciation Expense: Building
(P60,000 30)
Accumulated Depreciation: Building
Correct entries:
Building
Discount on Notes Payable
Notes Payable
a

60,000
60,000
2,000
2,000
40,981
19,019

60,000

P60,000 x 0.683013

Depreciation Expense: Building


Interest Expense
Accumulated Depreciation
Discount on Notes Payable
b

P40,981 30

Interest computed using effective


interest method: 10% x P40,981

Entries to correct error:


Discount on Notes Payable
Building
Accumulated Depreciation: Building

1,366
4,098

b
c

1,366
4,098

19,019
19,019
634

Comprehensive Audit of Balance Sheet and Income Statement Accounts


Interest Expense
Depreciation Expense: Building
Discount on Notes Payable
b.

c.

19-23

4,098
634
4,098

Retained Earnings
Cost of Goods Sold
To correct error from prior year.

40,000

Cost of Goods Sold


Inventory
To correct error in current year.

15,000

40,000

15,000

The error from 2005 was counterbalanced at


the end of 2006, so it can be ignored.
Retained earnings
Salaries and Wages Expense
To correct error in salary and wage
accrual in 2006.

18,000

Salaries and Wages Expense


Salaries and Wages Payable
To accrue salaries and wages at
December 31, 2007.

10,000

18,000

10,000

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 P4,098
amortized for 2007)
Accumulated Depreciation: Building
Retained Earnings
Building
d

b.

14,921
634
3,464

19,019

Correction of interest expense


understatement of P4,098 less
depreciation overstatement of P634

The error from 2006 was counterbalanced


by the end of 2005, so it can be ignored.
Retained Earnings
Inventory

15,000
15,000

19-24

Solutions Manual to Accompany Applied Auditing, 2006 Edition


c.

The errors from 2005 and 2006 were counterbalanced by the end of 2006 and
2007; respectively, so they can be ignored.
Retained Earnings
Salaries and Wages Payable

19-11.

10,000
10,000

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 that
relates 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 the
financial 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 COMPANY
Worksheet to Correct Income Before Income Taxes

Income before income taxes, before adjustments


Adjustments:
Depreciate certain equipment over 8-year life
instead of 10-year life (Schedule 1)
Correct 2006 error
Record 2007 provision for doubtful accounts
(P58,500,000 x 0.2%)
Increase estimated warranty liability
Effect of change in accounting principle from
expensing to capitalizing relining costs in the
year of the change (Schedule 2)
Furnace A (Jan. 2006)
Furnace B (Jan. 2007)
Net adjustments
Income before income taxes

Year Ended December 31


2007
2006
P4,030,000
P3,330,000
(25,000)
180,000
(117,000)
(170,000)

(56,000)
240,000
52,000
P4,082,000

-(180,000)
---

224,000
-44,000
P3,374,000

Comprehensive Audit of Balance Sheet and Income Statement Accounts

19-25

Schedule 1:
Computation of Adjusted Depreciation
Cost of equipment (no salvage value)

P1,000,000

Depreciation based on 10-year life


Depreciation based on 8-year life
Adjustment
Schedule 2:
Computation of Effect of Change in Accounting
Principle From Expensing to Capitalizing
Relining Costs on the Year of the Change
Capitalization of Furnace B
Depreciation on Furnace B based on 5-year life
(P300,000 x 20%)
Depreciation on Furnace A based on 5-year life
(P280,000 x 20%)
Adjustment

P 100,000
(125,000)
P (25,000)

P300,000
(60,000)
(56,000)
P184,000

Requirement (2)
PLAY COMPANY
Effect Before Income Taxes
of Change in Accounting Principle From
Expensing to Capitalizing Relining Costs
For Year Ended December 31, 2007
Capitalization of Furnace A
Depreciation on Furnace A based on 5-year life
(P280,000 x 20%)
Adjustment
19-12.

P280,000
(56,000)
P224,000

Jo Francisco, Inc.
Item
1.
2.
3.
4.
5.
6.

Net Income for 2005


Understated
Overstated
P14,100
0
P 7,000
0
0
P22,000
P33,000
0
0
P20,000
P18,200
0

Retained Earnings 12/31/06


Understated
Overstated
0
0
P 5,000
0
0
P11,000
P33,000
0
0
P10,000
0
0

Although explanations were not required in answering the question, they are
included below for your interest.

19-26

Solutions Manual to Accompany Applied Auditing, 2006 Edition


Explanations:

19-13.

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) so
that the Balance Sheet (Retained Earnings) would be correct at the end of
2006.

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 be
taken 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. At
the 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 the
end 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 was


omitted. 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 is
understated, 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.

JC Patrick Corporation
Net income, as reported
Rent received in 2006, earned in 2007

2006
P29,000
(1,300)

2007
P37,000
1,300

Comprehensive Audit of Balance Sheet and Income Statement Accounts


Wages not accrued, 12/31/05
Wages not accrued, 12/31/06
Wages not accrued, 12/31/07
Inventory of supplies, 12/31/05
Inventory of supplies, 12/31/06
Inventory of supplies, 12/31/07
Corrected net income

1,100
(1,500)
(1,300)
740
P26,740

19-27

1,500
(940)
(740)
1,420
P39,540