Problem 31 - 2: (Effect on Current Year Income)

Chippy Corporation failed to recognize accruals and prepayments since the inception of its business Prepaid insurance
three years ago. The accruals and prepayments at the end of 2014 are given below. Insurance expens

Prepaid insurance P60,000 Salaries expense

Accrued wages 75,000 Salaries expen
Rent revenue collected in advance 96,000
Interest receivable 81,000 Rent income
Unearned rent
What is the net effect of the above errors in the 2014 net income?
a) P 30,000 overstated Interest receivable
b) P 30,000 understated Interest incom
c) P120,000 understated
d) P120,000 overstated

Answer: a

Effect of Net Income

Understated (Overstated)
Understatement of prepaid insurance P60,000
Understatement of accrued wages (75,000)
Understatement of rent revenue collected in advance (96,000)
Understatement of interest receivable 81,000
Overstatement of net income (P30,000)

• Failure to recognize prepaid insurance at the end of the year will result to an overstatement of
expense, in effect; the net income will be understated in the same year.
• Non-recognition of accrued wages at the end of the year will result to an understatement of expense,
in effect; the net income will be overstated.
• Failure to recognize unearned rent revenue at year-end will result to an overstatement of rental
income, in effect; the net income will likewise be overstated.
•Omission or non-recognition of interest receivable will result to an understatement of interest
income, in effect; the net income will be understated, as well.

Problem 31 - 3: (Correct Net Income)

While examining the December 31, 2014 financial statements of Darwin Company, you discovered
the following:
a) Inventory at January 1, 2014 had been overstated by P30,000.
b) Inventory at December 31, 2014 was understated by P50,000.
c) During 2014, Darwin received a P100,000 cash advance from a customer for merchandise to be
manufactured and shipped during 2014. The amount was credited to sales revenue.
d) The net income reported on the 2014 profit or loss before reflecting any adjustments for the
above items is P3,000,000.
 d) The net income reported on the 2014 profit or loss before reflecting any adjustments for the
above items is P3,000,000.

What is the corrected net income for the year ended December 31, 2014?
a) P2,920,000
b) P2,980,000
c) P3,040,000
d) P3,080,000

Reported net income P3,000,000

a) Overstatement of January 1, 2014 inventory 30,000
b) Understatement of December 31, 2014 inventory 50,000
c) Sales for 2014 recognized in 2014 0 No effect.
Correct net income, 2014 P3,080,000

• Overstatement of the January 1, 2014 inventory overstates cost of sales resulting to an

understatement of net income.
• Understatement of the December 31, 2014 inventory overstates cost of sales resulting to an
understatement of net income.
• A sale for 2014 recognized in 2014 has no effect to the net income. This is properly recorded,
hence, no adjustment or correction shall be made.

Problem 31 - 4: (Correct Net Income)

Shakespeare Company has determined its 2014 and 2015 net income figures to be P1,150,000 and
P1,100,000, respectively. In a first time audit of the company's financial statements, you determine
the following errors:
a) Merchandise inventory was incorrectly determined: P50,000 overstatement for 2014 and P150,000
overstatement for 2015.
b) Revenue received in advance in 2014 of P250,000 was credited to a revenue account when
received. Of the total, P50,000 was earned in 2014, P120,000 was earned in 2015 and the remainder
will be earned in 2016.
c) P120,000 gain on sale of plant assets in 2015 was erroneously credited to Accumulated Profits and
Losses.

What is the corrected net income for the year 2015?

a) P 900,000
b) P1,120,000
c) P1,190,000
d) P1,240,000

□ Overstatement of beginning inventory overstates cost of sales, as a result, it will understate current
year (2015) net income.
□ Overstatement of ending inventory understates cost of sales resulting to an overstatement of current
year net income.
□ Overstatement of ending inventory understates cost of sales resulting to an overstatement of current
year net income.
□ Understatement of gain or revenue will understate current year net income.

Problem 31 - 5: (Adjusted Beginning Accumulated Profits)

Glorious Company reported an Accumulated Profits and Losses balance of P300,000 at December 31,
2014. In June 2015, Glorious discovered that merchandise costing P100,000 had not been included in
inventory in its 2014 financial statements. Assume Glorious has 32% tax rate. What amount should
Glorious report as adjusted beginning Accumulated Profits and Losses on January 1, 2015?
a) P232,000
b) P300,000
c) P368,000
d) P400,000

Answer: c

Accumulated profits, December 31, 2014,

or January 1, 2015 P300,000
Understatement in inventory for 2014 P100,000
x Net of tax rate 68% 68,000
Adjusted January 1, 2015 accumulated profits P368,000

Problem 31 - 6: (Adjusted Beginning Accumulated Profits)

Caramel Company reported a Retained Earnings balance of P400,000 at December 31, 2014. In
August 2015, Caramel Company determined that insurance premiums of P75,000 for the three-year
period beginning January 1, 2014, had been paid and fully expensed in 2014. Assume Caramel has a ###
32% income tax rate. What amount should Caramel report as adjusted beginning Retained earnings in ###
2015? 8
a) P366,000 ###
b) P425,000
c) P434,000
d) P450,000

Answer: c

Accumulated profits, December 31, 2014 P400,000

Overstatement of expense P50,000
x Net of tax rate 68% 34,000
Adjusted accumulated profits, January 1, 2015 P434,000

Problem 31 - 7: (Inventory Error)

On December 30, 2014, Forever18 Corporation sold merchandise for P75,000 to Bench Company.
The terms of the sale were n/30, FOB shipping point. The merchandise was shipped on December 31,
2014, and arrived at Bench Company on January 2, 2015. Due to a clerical error, the sale was not
recorded until January 215 and the merchandise, sold at a 25 % markup on cost, was included in
Forever18's inventory at December 31, 2014. As a result, Forever18's cost of goods sold for the year
ended December 31, 2014 was --
On December 30, 2014, Forever18 Corporation sold merchandise for P75,000 to Bench Company.
The terms of the sale were n/30, FOB shipping point. The merchandise was shipped on December 31,
2014, and arrived at Bench Company on January 2, 2015. Due to a clerical error, the sale was not
recorded until January 215 and the merchandise, sold at a 25 % markup on cost, was included in
Forever18's inventory at December 31, 2014. As a result, Forever18's cost of goods sold for the year
ended December 31, 2014 was --
a) Understated by P15,000
b) Understated by P60,000
c) Understated by P75,000
d) Correctly stated

Answer: b

The December 31, 2014 inventory was overstated. Therefore, cost of goods sold for 2014 was
understated by P60,000 (P75,000 ÷ 125%).

Problem 31 - 8: (Inventory Error)

Dalmatian Company's beginning inventory at January 1, 2014 was understated by P26,000 and its
ending inventory was overstated by P52,000.

As a result, Dalmatian's cost of goods for 2014 was -

a) P26,000 understated
b) P26,000 overstated
c) P78,000 understated
d) P78,000 overstated

Answer: c

January 1 inventory-understated P26,000

December 31 inventory-overstated 52,000
Cost of goods sold-understated P78,000

Understatement of beginning inventory resulted in an understatement of cost of sales, while

overstatement of inventory end understates cost of sales.

Problem 31 - 9: (Adjusted Income and Accumulated Profits)

Sundae Company started operations on January 1, 2011. Financial statements for 2014 and 2015
contained the following errors:

December 31, 2014 December 31, 2015

Ending inventory P55,000 too high P65,000 too low
Depreciation expense P35,000 too high -
Insurance expense P25,000 too low P25,000 too high
Prepaid insurance P25,000 too high -

Additionally, a fully depreciated equipment was sold for P12,000 on December 31, 2015. The sale
was not recorded until 2016. No corrections have been made for any of the errors. (Ignore income
tax considerations).
Additionally, a fully depreciated equipment was sold for P12,000 on December 31, 2015. The sale
was not recorded until 2016. No corrections have been made for any of the errors. (Ignore income
tax considerations).

Question 1: How much would be the total effect of the error in Sundae's 2015 net income?
a) Overstated by P48,000
b) Overstated by P83,000
c) Understated by P102,000
d) Understated by P157,000

Answer: d

2014 2015
Ending inventory:
2014 too high (P55,000) P55,000
2015 too low 65,000
Depreciation-2014 too high 35,000
Insurance expense-2014 too low (25,000) 25,000
Unrecorded gain 12,000
Effect on net income (P45,000) P157,000

Question 2: How much would be the understatement in Sundae's Accumulated Profits balance
at December 31, 2015?
a) P 77,000
b) P112,000
c) P132,000
d) P137,000

Answer: b

Under (Over)
Effect on 2014 net income (P45,000)
Effect on 2015 net income 157,000
Net effect on December 31, 2015 Accumulated Profits P112,000

Problem 31 - 10: (Adjusted Income and Accumulated Profits)

Sunsilk Company's December 31 year-end financial statements had the following errors:

December 31, 2014 December 31, 2015

Ending inventory P13,500 understated P19,800 overstated
Depreciation expense P3,600 understated -
Unearned rental P5,000 understated -
Prepaid insurance P8,000 understated

There were no other errors during the years 2014 or 2015 and no corrections have been made for any
of the errors. (Ignore income tax considerations).
Question 1: What is the net effect of the errors on Silk's 2015 net income?
a) Understated by P13,000
b) Overstated by P14,800
c) Overstated by P20,300
d) Overstated by P25,300

Answer: c

Effect on
12/31/2015
Net Income Accum. Profits
2014 2015
Ending inventory:
2014-understated P13,500 (P13,500) P 0
2015-overstated - (19,800) (19,800)
Depreciation-2014 under (3,600) - (3,600)
Unearned rental-2014 under (5,000) 5,000 -
Prepaid insurance-2015 under 8,000 8,000
Net effect (over) understated P4,900 (P20,300) (P15,400)

Question 2: What is the net effect of the errors in Sunsilk's December 31, 2015 accumulated profits
balance?
a) Overstated by P11,800
b) Overstated by P15,400
c) Understated by P20,300
d) Overstated by P20,300

Answer: b

Question 3: What is the net effect of the Sunsilk's December 31, 2015 working capital?
a) Understated by P4,900
b) Understated by P8,000
c) Overstated by P11,800
d) Understated by P20,300

Answer: c

Effect on Working
Capital (for 2015)
2015 overstatement of inventory (P19,800)
2015 understatement of prepaid insurance 8,000
Net effect on the working capital (over) (P11,800)
The errors in 2014 inventory and unearned rental no longer affect the working capital as of December
31, 2015 since both errors had counterbalanced while error in depreciation does not affect working
capital because depreciation is related to an asset not classified as current.

Problem 31 - 11: (Effect of Errors on Accumulated Profits)

Records showed that as of December 31, 2014, accrued salaries payable of P21,000 were not recorded
in Retro Company's books. In addition, office supplies on hand of P9,000 at December 31, 2015 were
erroneously treated as expense instead of supplies inventory. Neither of these errors was discovered
not connected.

What is the effect of these two errors?

a) 2015 net income is understated by P30,000 and January 1, 2016 accumulated profits is
understated by P9,000.
b) 2014 net income and December 31, 2014 accumulated profits are understated by
P21,000 each.
c) 2014 net income is overstated by P12,000 and 2015 net income is understated by
P9,000.
d) 2015 net income and December 31, 2015 accumulated profits are understated by P9,000
each.

Answer: a

Accumulated
Net Income Profits
2014 2015 Jan. 1, 2016
Unrecorded accrued salaried in 2014 (P21,000) P21,000 P 0
Office supplies on hand in 2015 charged
to expense 9,000 9,000
Net effect - (overstated) understated (P21,000) P30,000 P9,000

• Understatement of accrued salaries understates salaries expense, in effect, overstates current year's
net income. Consequently, the following year's net income will be understated.
• The understatement of supplies on hand overstates the supplies expense, in effect, understates
current year's net income.

Problem 31 - 12: (Effect on Working Capital)

Blink Corporation started operations on January 1, 2014. Financial statements for the years ended
December 31, 2014 and 2015 contained the following errors:

2014
Ending inventory P240,000 understated
Depreciation expense 90,000 understated
Insurance expense 150,000 overstated
Prepaid insurance 150,000 understated
2015
P225,000 overstated
150,000 understated
Additionally, a fully depreciated equipment was sold for cash of P162,000 on December 31, 2015.
The sale was not recorded until 2016. There were no other errors during 2014 or 2015 and no
corrections have been made for any of the errors. What is the total effect of the errors in the amount
of the working capital at December 31, 2015? (Ignore income taxes).
a) Overstated by P63,000
b) Understated by P87,000
c) Understated by P90,000
d) Understated by P147,000

Answer: a

Working Capital
2014 2015 Dec. 31, 2015
Inventory-2014 under P240,000 (P240,000)
Inventory-2014 over (225,000) (P225,000)
Depreciation-2014 under (90,000) 0 0
Prepaid insurance under 150,000 (150,000) 0
Gain on sale of equipment 162,000 162,000
Net correction P300,000 (P453,000) (P63,000)

Depreciation error does not affect working capital since it is identified or related to a non-current
asset.

Problem 31 - 13: (Net Effect on Net Income)

While examining the accounts of Germania Company on December 31, 2015, the following errors
were uncovered:

1) Dividends of P100,000 had been declared on December 15, 2015 but was not recorded in the
books.
2) Improvements in buildings and equipment for P480,000 had been debited to expense at the end of
April in 2014. Improvements are estimated to have an estimated life of 8 years.
3) The company failed to record sales commissions payable amounting to P10,500 and P19,000 at the
end of 2014 and 2015, respectively.
4) Supplies on hand amounting to P6,000 and P15,000 were not recognized at the end of 2014 and
2015, respectively.

Question 1: What is the net effect of the above errors in the 2014 net income?
a) P423,500 under
b) P435,500 under
c) P463,500 under
d) P475,500 under

Question 2: What is the net effect of the error in the 2015 net income?
a) P59,500 over
b) P70,000 over
c) P74,500 over
 d) P85,000 over

Answers:
Question 1: b
Question 2: a

Effect in Net Income

2014 2015
a. Unrecorded dividends No effect No effect
b. Leasehold improvements charged to
expense P480,000 under
understatement of depreciation
2014 (P480,000 ÷ 8 x 8/12) 40,000 over
2015 (P480,000 ÷ 8) P60,000 over
c. Unrecorded sales commissions
2014 10,500 over 10,500 under
2015 19,000 over
d. Unrecorded supplies on hand
2014 6,000 under 6,000 over
2015 15,000 under
Net effect P435,500 under (1) P59,500 over (2)

Problem 31 - 14: (Effect on Accumulated Profits)

The following errors were discovered in the course of examination of the Diamond Company's
financial records:

□ Year 2014 wages payable for P34,000 was not recorded.

□ Accrued vacation pay for the year 2014 for P62,500 was not recorded because the bookkeeper
"never learned that you had to do it".
□ Insurance for a 12-month period purchased on November 1, 2014 was charged to expense in the
amount of P37,200 because "the amount of the check is about the same every year".

What is the net effect of the above errors on the January 1, 2015 accumulated profits?
a) P59,300 over
b) P65,500 over
c) P96,500 over
d) P127,500 over

Answer: b

Accumulated Profits
Jan. 1, 2015
Under (Over)
Unrecorded wages payable (P34,000)
Accrued vacation pay for 2014 not recorded (62,500)
Overcharging of insurance expense during 2014
 (P37,200 x 10/12) 31,000
Net effect on the 01/01/15 Accumulated Profits (P65,500)

Problem 31 - 15: (Effect on Accumulated Profits)

Evergreen Company discovered the following errors in its financial records at the beginning of the
year 2015:

a. The physical inventory count on December 31, 2014 excluded a merchandise with a cost of
P38,000 that had been temporarily stored in a public warehouse. Evergreen uses the periodic
inventory system.
b. During 2014, A competitor filed a patent infringement suit against Evergreen claiming damages of
P440,000. The company's legal counsel has indicated that an unfavorable verdict is probable and a
reasonable estimate of the court's award to the competitor is P250,000. The company has not reflected
or disclosed this situation in the financial statements.

c. A trademark was acquired at the beginning of 2013 for P100,000. No amortization has been recorded since acquisition. It is

What is the effect of the above errors on the January 1, 2015 accumulated profits?
a) P214,500 overstated
b) P217,000 overstated
c) P222,000 overstated
d) P293,000 overstated

Answer: c

Accumulated Profits
January 1, 2015
Under (Over)
A. Company's inventory, excluded in the physical count P38,000
B. Failure to recognize a probable & reasonable amount
of estimated loss (250,000)
C. Failure to amortize trademarks (P100,000 ÷ 20 x 2) (10,000)
Net effect (P222,000)
Prepaid insurance 60,000 Net income 200,000
Insurance expense (60,000) A. Insurance 60,000
B. Salaries (75,000)
Salaries expense 75,000 C. Rent (96,000)
Salaries expense payab (75,000) D. Interest 81,000
Corrected Net Income 170,000
Rent income 96,000
Unearned rent income (96,000) 30,000

Interest receivable 81,000

Interest income (81,000)

Cost of Goods Sold Mali Tama

Scenario 1 Correction Scenario 2
Beg. Inv. 200,000 (30,000) 170,000
Plus: Purchases 400,000 - 400,000
Less: End. Inv. 150,000 50,000 200,000
Cost of Good Sold 450,000 (80,000) 370,000
Revenue 3,450,000 - 3,450,000
Cost of Good Sold 450,000 370,000
Net Income 3,000,000 - 3,080,000

Cash 100,000
Sales Revenue (100,000)

2,014 2015 2016

Net Income 1,150,000 1,100,000
A. Inventory End (50,000) 50,000
(150,000) 150,000
B. Unearned Income (250,000)
50,000 120,000 80,000
C. Gain on sale 120,000
Corrected Net Income 900,000 1,240,000 230,000

Cash xx
Accu Dep xx RE 120,000
PPE (xx) Gain on sale (120,000)
RE (120,000)
100,000
0.32
32,000
68,000
300,000
368,000

75,000
25,000

50,000
0.32
16,000
34,000
400,000
434,000

75,000 Revenue is equal to Cost * 1.25

 60,000 Cost 10
0.25
15,000 GP 2.50
SP 12.50

Error Correction Adjusted

Inv., beg 100,000 26,000 126,000
Purchases 300,000 - 300,000
Inv., end 120,000 (52,000) 68,000
COGS 280,000 78,000 358,000

2014 2015 2016

End., Inv (55,000) 55,000
65,000 (65,000)
Depn Exp 35,000 -
Ins Exp (25,000) 25,000
Sale of PPE 12,000 (12,000)
Net effect (45,000) 157,000 (77,000)
112,000
Insurance expense 25,000
Prepaid Insurance (25,000)

2014 2015 2016

Inv., End 13,500 (13,500)
(19,800) 19,800
Dep Exp (3,600) -
Unearned rental (5,000) 5,000
Prepaid insurance 8,000 (8,000)
Net effect 4,900 (20,300)
(15,400)
Rent Income 5,000
Unearned rental (5,000)
Prepaid insurance 8,000
Insurance expense (8,000) Error

Correction

Error

Correction
rded since acquisition. It is the company's policy to amortize all intangibles with a definite life for a maximum of 20 years. At the time of
Ending Inventory (Indirect Relationship with COGS)
If ending inventory is understated, COGS is overstated.
If ending inventory is understated, Net Income is understated.
If ending inventory is overstated, COGS is understated.
If ending inventory is overstated, Net Income is overstated.

Beginning Inventory (Direct relationship with COGS)

If beginning inventory is understated, COGS is understated.
If beginning inventory is understated, Net Income is overstated.
If beginning inventory is overstated, COGS is overstated.
If beginning inventory is overstated, Net Income is understated.

LIABILITY (Indirect relationship with Net Income)

If liability is understated, income is overstated.
If liability is overstated, income is understated.

ASSET (Direct relationship with Net Income)

If asset is understated, income is understated.
If asset is overstated, income is overstated.

3 tenants paying P5,000 each

Tenant #3 - paid in advance her share.
2014 2015
Cash 15,000 No entry
Rental Income (15,000)

Rent Income 5,000 Unearned rental 5,000

Unearned rental (5,000) Rental income (5,000)

Prepaid insurance (Good for two years)

Insurance expense 16,000 No entry
Cash 16,000

Prepaid insurance 8,000 Insurance expense 8,000

Insurance expense (8,000) Prepaid insurance (8,000)
maximum of 20 years. At the time of acquisition, the trademark was estimated to have a definite life of 20 years.
 Chapter 31

CORRECTION OF ERRORS
 Building 1,000,000.00
Useful Life 20.00

Annual Depreciation 50,000.00

After Five years

Useful life 10.00

Remaining life 5.00

Building 1,000,000.00
Useful Life 10.00

Tama Annual Depreciation 100,000.00

Wrong Useful Life 20.00

Annual Depreciation 50,000.00

Seven years
Total Depn as of Date 350,000.00

Correct Depn as of Date 700,000.00

Correcting entry 350,000.00

 Building 1,000,000.00
Accu Dep 250,000.00
Carrying Amount 750,000.00

150,000.00

50,000.00 50,000.00