1

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

AUDITING PROBLEMS
Accounting 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 conditions
3. Changes in technology and in operations
4. New experience or new information may prompt companies to change its estimate of
revenues or expenses.

TYPES OF ACCOUNTING CHANGES

1. 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 Estimate

This 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.
b. Present prior period financial statements as previously reported.
c. Make no adjustment to current period opening balances.
 2

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 ERRORS
No 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 mistakes
c. Mistake in the application of accounting of accounting principle
d. Oversight
e. Misuse of facts
f. Incorrect classification of expense as an asset or vice versa
g. Changes in estimates which are not prepared in good faith

TYPES OF ERRORS
1. 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 income
2. 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.

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.
 3

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. Sales
2. Prepaid expenses
3. Deferred Income
4. Accrued expense
5. 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 closed
1. 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 ANALYSIS

1. 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 1
In 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.
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.
 4

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 2
In 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 open
b. 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 DATE
11.01.03 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 2004
2. 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%.
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 P300,000 P352,000
KEVIN 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 Bad
Debt Expense Actual
Year Sales (% of Sales) Bad Debts
2001 P 87,000 P2,610 P1,200
2002 123,000 3,690 2,850
2003 147,000 4,410 3,222
 5

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

__________________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
 6

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 4
An 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 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 546,875
2004 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 open
b. Books are closed

Problem 5
In 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
 7

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. 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 500,000
2004 375,000

Problem 6
For 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 2004

Unadjusted net income (loss) 150,000 500,000
( 125,000)
1. Checks written in December and mailed on January 3
of the following year. 250 375 500
2. Overstatement of ending inventories 36,000 28,000 -
3. Failed to recognize unearned revenue - 6,250 11,250
4. Failed to record purchase on account and mdse
properly included in ending inventory - - 50,000
5. Failed to recognize unused supplies at the end of year 3,750 - 5,000
6. Failed to record accrued commission expenses 25,000 31,250 60,000
7. Understatement of depreciation expenses 15,000 18,750 18,750
8. Worthless accounts written not written off by year end 625 750 875
9. Failed to recognize gain on sale of land; Land credited for
the proceeds 75,000
 8

10. 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 7
1. 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 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 2004
2003 accounts P 200 P 1,000
2004 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 8
INVENTORIES
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.
 9

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 6
Income Statement- 2004
Purchases ____ ____ ____ _____ _____ _____
Cost of Sales ____ ____ ____ _____ _____ _____
Net income ____ ____ ____ _____ _____ _____
Balance Sheet- December 31, 2004
Inventory ____ ____ ____ _____ _____ _____
Accounts Payable ____ ____ ____ _____ _____ _____
RE before closing ____ ____ ____ _____ _____ _____
RE after closing ____ ____ ____ _____ _____ _____
Income Statement- 2005
Purchases ____ ____ ____ _____ _____ _____
Beginning inventory ____ ____ ____ _____ _____ _____
Ending inventory ____ ____ ____ _____ _____ _____
Cost of Sales ____ ____ ____ _____ _____ _____
Net income ____ ____ ____ _____ _____ _____

Balance Sheet- December 31, 2005

Inventory ____ ____ ____ _____ _____ _____
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 ____ _____ _____ _____
 10

RE before closing ____ _____ _____ _____

RE after closing ____ _____ _____ _____

Problem 10
You 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 CAPITAL

Cash 192,500 Accounts payable 175,000
Accounts receivable 192,500 Notes payable 52,500
Notes receivable 227,500 Common stock
350,000
Inventory 437,500 Retained earnings 472,500
Total 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 2004
Overstatement of inventory - 122,500 140,000
-
Understatement of inventory 105,000 - -
157,500
Prepaid expense 15,750 12,250 8,750 10,500
Unearned revenue - 7,000 - 5,250
Accrued 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 Companys beginning inventory at January 1, 2004 was understated by P45,500,
and its ending inventory was overstated by P91,000. As a result, Sean Companys cost of
goods sold for 2004 was:

a. Understated by P45,500
b. Overstated by P45,500
c. Understated by P136,500
d. 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 26,880
 11

b. P 33,600
c. P 42,000
d. P 53,760
3. Brandy Corp. reports on a calendar-year basis. Its 2004 and 2005 financial statements
contained the following errors:
2004 2005
Over (under) statement of ending inventory P10,000 P 4,000
Understatement of depreciation 4,000 6,000
Failure to accrue salaries at year end 8,000 12,000

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

a. overstated by P4,000
b. overstated by P24,000
c. overstated by P22,000
d. 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 321,300
b. P 367,200
c. P 378,000
d. 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 0
b. P 100,000
c. P 150,000
d. 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 219,000
b. P 231,000
c. P 240,000
d. 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 2005
Unearned 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 P146,000
b. understated by P146,000
c. understated by P26,000
d. 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
 12

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
b. P 154,000
c. P 175,000
d. 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 P12,800
b. Net income is overstated by P3,600
c. Net income is understated by P1,600
d. 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 0
b. P 30,000
c. P 37,500
d. 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 15,360
b. P 19,200
c. P 24,000
d. 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 363,750
c. P 369,750
d. P 345,000
13. Jerry Company reported a net income of P525,000 in 2004. Your audit disclosed the
following:
2004 2005
Overstatement of ending inventory 21,750 24,750
Omission of depreciation 11,250 11,250
Understatement of commission receivable 16,500 13,500
Purchase of mdse not recorded but included in
the year end inventory 45,000
Adjusted net income for 2004 is:
a. P 525,000
b. P 507,750
 13

c. P 531,000
d. P 552,750
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 Saugies inventory at December 31, 2004. As a result,
Saugies cost of goods sold for the year ended December 31, 2004 was:
Understated by P56,250
Understated by P45,000
Understated by P11,250
Correctly 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 2004
Accrued expenses 4,500 7,500 6,500
Prepaid expenses 5,000 12,000 8,000
Prepaid revenues 1,200 2,750
Revenues receivable 3,000 2,500
Retained 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 444,300
b. P 450,000
c. P 578,500
d. P 445,000
17. The corrected net income for the years ended December 31, 2003 and 2004 are:
2003 2004
a. P126,000 P150,000
b. P134,200 P143,750
c. P146,700 P168,000
d. 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?
a. P 125,000
b. P 150,000
c. P 187,500
d. P 250,000
 14

19. Combs, Inc. is a calendar-year corporation whose financial statements for 2004 and
2005 included errors as follows:
Ending Inventory Depreciation Expense
2004 P30,000 overstated P25,000 overstated
2005 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 increase
b. P 27,000 decrease
c. P 7,000 decrease
d. P 3,000 decrease

20. Koppell Co. made the following errors in counting its year-end physical inventories:
2003 P 60,000 overstatement
2004 108,000 understatement
2005 90,000 overstatement
As a result of the above undetected errors, 2005 income was
a. Understated by P18,000
b. Overstated by P198,000
c. Overstated by P18,000
d. Understated by P198,000
21. Koppell Co. made the following errors in counting its year-end physical inventories:
2003 P 60,000 overstatement
2004 108,000 understatement
2005 90,000 overstatement
The entry to correct the accounts at the end of 2005 is
a. Retained earnings 48,000
Cost of sales 42,000
Inventory 90,000

b. Retained earnings 18,000

Cost of sales 72,000
Inventory 90,000

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

d. Cost of sales 198,000

Retained earnings 108,000
Inventory 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.

Income reported for 2004 before reflecting any adjustment for the above
information is P187,500. The correct income for 2004 is:
a. P 255,000
b. P 221,250
c. P 165,000
d. P 150,000
 15

23. Tom Companys beginning inventory at January 01, 2004 was understated by P45,500
and its ending inventory was overstated by P91,000. As a result, Tom Companys cost of goods
sold for 2004 was:
a. Understated by P45,500
b. Overstated by P45,500
c. Understated by P136,500
d. 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 2004
Rent received in advance 22,500 30,000
Accrued salaries 13,500 18,000
Prepaid interest 33,750 45,000
Commission receivable 15,750 14,625
Depreciation expense 26,250 26,250
Equipment 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 598,875
b. P 613,875
c. P 655,125
d. P 681,375
25. The first examination of Tamers 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 earnings
a. P 0 P75,000
b. P15,000 P30,000
c. P25,000 P 0
d. P45,000 P 0

END