CHAPTER 10

PRIOR PERIOD ERRORS

Effective January 1, 2016, King Company adopted the accounting policy of expensing advertising and
promotion costs when incurred. Previously, advertising and promotion costs applicable to future periods
were recorded in prepaid expenses. The entity can justify the change, which was made for both financial
statement and income tax reporting purposes. The prepaid advertising and promotion costs totaled P600,000
on December 31, 2016. The income tax rate is 30%.

What is the net charge against income for 2016 as a result of the change?

a) 600,000
b) 180,000
c) 420,000
d) 0

Solution 10-1 Answer d

The entity committed an error of deferring advertising and promotion costs.

A prior period error is not included in profit or loss but treated as an adjustment of the beginning balance of
retained earnings.

Problem 10-2 (AICPA Adapted)

On January 1, 2015, Aker Company acquired a machine at a cost of P2,000,000. The machine is depreciated
on the straight line method over a five-year period with no residual value. Because of a bookkeeping error, no
depreciation was recognized in the 2015 financial statements. The oversight was discovered during the
preparation of the 20166 financial statements.

What is the depreciation expense on the machine for 2016?

a) 800,000
b) 400,000
c) 500,000
d) 0

Solution 10-2 Answer b

Depreciation for 2016 (2,000,000 / 5) 400,000

Problem 10-3 (IFRS)

Harbor Company reported the following events during 2016:

 It was decided to write off P800,000 from inventory which was over two years old as it was obsolete.
 Sales of P600,000 had been omitted from the financial statements for the year ended December 31,
2015.

What total amount should be reported as prior period error in the financial statements for the year ended
December 31, 2016?

a) 1,400,000
b) 600,000
c) 800,000
d) 200,000

Solution 10-3 Answer b

Only the unrecorded sale of P600,000 on December 31, 2015 is treated as prior period error in the financial
statements for 2016.

The writeoff of the inventory of P800,000 is included in the profit or loss for 2016.

Problem 10-4 (PHILCPA Adapted)

Universal Company failed to accrue warranty cost of P100,000 on December 31, 2015. In addition, a change
from straight line to accelerated depreciation made at the beginning of 2016 resulted in a cumulative effect of
P60,000 on retained earnings.

What pretax amount should be reported as a prior period error in 2016?

a) 100,000
b) 160,000
c) 60,000
d) 0

Solution 10-4 Answer a

Only the unrecorded warranty cost of P100,000 on December 31, 2015 should be accounted for as a prior
period error.

The change in depreciation method is a change in accounting estimate.

Problem 10-5 (IFRS)

Extracts from the statement of financial position of Animus Company showed the following:

December 31, 2017 December 31, 2016

Development costs 8,160,000 5,840,000

Amortization (1,800,000) (1,200,000)

The capitalized development costs relate to a single project that commenced in 2014.

It has now been discovered that one of the criteria for capitalization has never been met.

1. What adjustment is required to restate retained earnings on January 1, 2017?

a) 6,360,000
b) 1,720,000
c) 4,640,000
d) 0

2. What amount of the development costs should be expensed in 2017?

a) 5,840,000
b) 6,360,000
c) 1,720,000
d) 0

Solution 10-5

Question 1 Answer c

Development costs - December 31, 2016 5,840,000

Amortization (1,200,000)

Carrying Amount - December 31, 2016 4,640,000

The entity committed an error in capitalizing development costs.

Thus, the carrying amount of P4,640,000 on December 31, 2016 is treated as a prior period error in the
statement of retained earnings for 2017.
Question 2 Answer c

The remainder of the carrying amount of the development costs on December 31, 2017 should be expensed
in 2017.

Development costs - December 31, 2017 8,160,000

Amortization (1,800,000)

Carrying amount - December 31, 2017 6,360,000

Carrying amount - December 31, 2016 4,640,000

Remaining carrying amount 1,720,000

Problem 10-6 (IFRS)

In reviewing the draft financial statements for the year ended December 31, 2017, Bituin Company decided
that market conditions were such that the provision for inventory obsolescence on December 31, 2017
should be increased by P3,000,000.

If the same basis of calculating inventory obsolescence had been applied on December 31, 2016, the
provision would have been P1,800,000 higher than the amount recognized in the statement of comprehensive
income.

1. What adjustment should be made to the income of 2017?

a) 3,000,000 decrease
b) 3,000,000 increase
c) 1,200,000 decrease
d) 1,200,000 increase

2. What adjustment should be made to the net income of 2016 presented as a comparative figure in the 2017
financial statements?

a) 1,800,000 decrease
b) 1,800,000 increase
c) 3,000,000 decrease
d) 0

Solution 10-6

Question 1 Answer a

The increase in the provision for inventory obsolescence on December 31, 2017 of P3,000,000 is deducted
from the net income of 2017.

Question 2 Answer d

The increase in the provision for the inventory obsolescence in 2016 is ignored because this is considered a
change in accounting estimate.
Problem10-7 (IFRS)

Samar Company reported the following events during the year ended December 31, 2017:

 A counting error relating to the inventory on December 31, 2016 was discovered.

This required a reduction in the carrying amount of inventory at that date of P280,000.

 The provision for uncollectible accounts receivable on December 31, 2016 was P300,000.

During 2017, P500,000 was written off related to the December 31, 2016 accounts receivable.

What adjustment is required to restate retained earnings on January 1, 2017?

a) 280,000
b) 300,000
c) 580,000
d) 0

Solution 10-7 Answer a

The reduction in the carrying amount of inventory on December 31, 2016 of P280,000 is a prior period error
to be presented in the statement of retained earnings for 2017.

The provision for uncollectible accounts receivable is a change in accounting estimate and therefore has no
effect on retained earnings.

The change in accounting estimate should be treated currently and prospectively.

Problem 10-8 (AICPA Adapted)

After the issuance of the 2016 financial statements, Narra Company discovered a computational error of
P150,000 in the calculation of the December 31, 2016 inventory.

The error resulted in a P150,000 overstatement in the cost of goods sold for the year ended December 31,
2016.

In October 2017, the entity paid the amount of P500,000 in settlement of litigation instituted against it during
2016.

In the financial statements for 2017, what is the pretax adjustment of the retained earnings on January 1,
2017?

a) 150,000 credit
b) 350,000 debit
c) 500,000 debit
d) 650,000 credit
Solution 10-8 Answer a

The inventory on December 31, 2016 was understated resulting to overstatement of cost of goods sold and
understatement of net income for 2016.

Thus, the retained earnings should be increased and credited directly.

Inventory - January 1, 2017 150,000

Retained earnings 150,000

The settlement of the litigation in 2017 is included in the profit or loss of 2017.

Litigation loss 500,000

Cash 500,000

Problem 10-9 (IFRS)

Natasha Company reported net income of P700,000 for 2017. The entity declared and paid dividend of
P150,000 in 2017.

In the financial statements for the year ended December 31, 2016, the entity reported earnings of P1,100,000
on January 1, 2016.

The net income for 2016 was 600,000 and the entity declared and paid dividend of P300,000 in 2016.

In 2017, after the 2016 financial statements were approved for issue, the entity discovered an error in the
December 31, 2015 due to the underappreciation.

What amount should be reported as retained earnings on December 31, 2017?

a) 1,300,000
b) 1,400,000
c) 1,650,000
d) 1,950,000
Solution 10-9 Answer a

Retained earnings - January 1, 2016 1,100,000

Net income for 2016 600,000

Dividend declared and paid in 2016 (300,000)

Retained earnings - December 31, 2016 1,400,000

Net income for 2017 700,000

Prior period error in 2015 due to the underdepreciation (650,000)

Dividend declared and paid in 2017 (150,000)

Retained earnings - December 31, 2017 1,300,000

Problem 10-10- (AICPA Adapted)

While preparing the 2016 financial statements, Dek Comany discovered computational errors in the 2014 and
2015 depreciation expense.

These errors resulted in overstatement of each years income by P100,000, net of income tax.

The following accounts were reported in the previously issued financial statements.

2014 2015

Retained earnings, January 1 2,000,000 2,800,000

Net income 800,000 600,000

Retained earnings -December 31 2,800,000 3,400,000

The net income for 2016is correctly reported at P700,000.

What is the correct balance of retained earnings on December 31, 2016?

a) 3,900,000
b) 4,100,000
c) 4,300,000
d) 4,000,000
Solution 10-10 Answer a

Retained earnings - January 1, 2016 3,400,000

Prior period error

Underdepreciated in 2014 and 2015 (100,000 x 2) (200,000)

Corrected beginning balance 3,200,000

Net income for 2016 700,000

Retained earnings - December 31, 2016 3,900,000

Problem 10-11 (AICPA Adapted)

On January 1, 2016, Raven Company discovered that it had incorrectly expensed a P2,100,000 machine
purchased on January 1, 2013.

The entity estimated the machine's original useful life to be 10 years and the residual value at P100,000.

The entity used the straight line method of depreciation and is subject to a 30% income tax rate.

In the December 31, 2016 financial statements, what amount should be reported as a prior period error?

a) 1,659,000
b) 1,029,000
c) 1,050,000
d) 1,680,000

Solution 10-11 Answer c

Machine incorrectly expensed 2,100,000

Unrecorded depreciation for 20113, 2014 and 2015

(2,000,000 / 10 x 3 years) 600,000

Net overstatement of expense 1,500,000

Tax effect (30% x 1,500,000) (450,000)

Net understatement of retained earnings 1,050,000

Cost 2,100,000

Residual value (100,000)

Depreciable amount 2,000,000

The amount of 1,050,000 is a prior period error directly credited to retained earnings because net income of
prior years was understated.
Journal entry on January 1, 2016

Machinery 2,100,000

Accumulated depreciation 600,000

Retained earnings 1,050,000

Income tax payable 450,000