Week 3

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AUDITING AND ASSURANCE

PRINCIPLES, CONCEPTS,
AND APPLICATIONS
BACHELOR OF SCIENCE IN ACCOUNTANCY
3RD YEAR 1ST SEMESTER S.Y. 2021-2022
DESIREE D. CEMEFRANIA, CPA
 Cash Basis and Accrual Basis
Cash Basis accounting is a system that recognizes revenue when cash is received and expenses
when cash is paid.

Accrual Basis accounting is a system that recognizes revenue when earned and expenses as it is
incurred.

Transaction Cash Basis Accrual Basis

Sales Cash sales Cash Sales
Collection of Trade AR and Sales on Account
NR
Other Income Collection during the period Earned during the period

Purchases Cash purchase Cash Purchases

Payment of AP and NP Purchase on Account
Payment in advance to
supplier
Expenses Only expenses paid Incurred expenses (cash and
payable)
Depreciation Typically provided Typically provided
Bad Debts none Doubtful accounts
Slide 7
 Correction of Errors
Errors refers to unintentional misstatement in financial statements including the omission of an amount
or a disclosure including:

 Mistake in the gathering or processing of data

 Incorrect accounting estimate arising from oversight or misinterpretation of facts
 Mistake in the application of accounting principles relating to measurement, recognition,
classification, presentation or disclosure.

Fraud refers to intentional act by one or more individuals among management, those charged with
governance, employees or third parties, involving the use of deception to obtain an unjust or illegal
advantage.

Prior Period Errors omission from and misstatement in the financial statements for one or more prior
periods arising from a failure to use or misuse of reliable information that:

 Was available when financial statements for those periods were authorized for issue
 Could reasonably be expected to have been obtained and taken into account in the preparation
 Oversights or misinterpretation of facts
 Fraud
 Correction of Errors
PAS 8

Par 42: An entity shall correct material prior period errors retrospectively in the first set of financial
statements authorized for issue after discovery by:

 Restating the comparative amounts for the prior period(s) presented in which the error occurred; or

 If the error occurred before the earliest prior period presented, restating the opening balances of
assets, liabilities and equity for the earliest prior period presented.
 Correction of Errors
Types of Errors:

 Balance Sheet/ Statement of Financial Position errors

This affects balance sheet accounts only. If the error is discovered in the error year, the entity
reclassifies the item to its proper position. If the error is discovered in the subsequent period, the
company should restate the balance sheet of prior year for comparative purposes.

 Income Statement errors

This affects the income statement accounts only that may include improper classification of
revenues or expenses. If the error is discovered in the error year, the entity must make a
reclassification entry. It the error discovered pertains to prior year, the company should restate the
income statement for comparative purposes. Since this error involves nominal account, Net Income
and Retained Earnings during the period are unaffected.

 Combined errors – affects both income statement and balance sheet.

Correction of Errors
Cash to Accrual Basis

ABC Co. records all transactions on cash basis. Below is the company’s income statement at the end of
its first year of operations:
ABC Company You have been asked to prepare an Income Statement on
Income Statement the accrual basis given the ff information:
For the Year Ended Dec. 31, 20x1
Sales P 2,016,000 1. Amount due from the customer is Php 224,000.00. Out of
Selling and Administrative Expenses this P 24,000 is considered doubtful.
2. Salaries of P 88,000 for Dec 31, 20x1 were paid on jan 5,
Salaries Expense 624,000
20x2
Rent Expense 360,000 3. ABC Co. rents its building for P 24,000 per month,
Utilities Expense 232,000 payable quarterly in advance. The contract started at
Jan 1 20x1
Equipment 240,000
4. The bill for Dec utility is Php 21,600 paid in Jan 10, 20x2
Commission Expense 302,000 5. Equipment of P 240,000 was purchased on Jan 1, 20x1.
Insurance Expense 48,000 the expected life is 5 years with no salvage value. Use
straight line method.
Interest Expense 24,000 1,830,000
6. Commission of 15% of sales are paid on the same day
Net Income P 185,600 cash is received from customers.
7. A 1-year insurance policy was issued in company’s assets
QUESTION: in July 1, 20x1. Premiums are paid annually in advance.
8. ABC Co. borrowed P 400,000 for one year on May 1,
1. How much is the net income before tax under accrual basis of
accounting? 20x1. Interest payment based on annual rate of 12% are
made quarterly, beg. With the first payment on Aug 1,
a. P 286,000 20x1.
b. P 514,000 Cash Basis and
c. P 526,000
d. P 574,000
`Basis
SOLUTION:

You have been asked to prepare an Income Statement on

the accrual basis given the ff information:

1. Amount due from the customer is Php 224,000.00. Out of SOLUTION

this P 24,000 is considered doubtful.
Net Income - Cash Basis 185,600
2. Salaries of P 88,000 for Dec 31, 20x1 were paid on Jan 5,
20x2 AJE:
3. ABC Co. rents its building for P 24,000 per month, 1. Sales on Account 224,000
payable quarterly in advance. The contract started at
1. Doubtful Account -24,000
Jan 1 20x1
4. The bill for Dec utility is Php 21,600 paid in Jan 10, 20x2 2. Salaries Payable -88,000
5. Equipment of P 240,000 was purchased on Jan 1, 20x1. 3. Advanced rent payment 72,000
the expected life is 5 years with no salvage value. Use
4. Utility Payable -21,600
straight line method.
6. Commission of 15% of sales are paid on the same day 5. Equipment 240,000
cash is received from customers. 5. Depreciation -48,000
7. A 1-year insurance policy was issued in company’s assets
6. Commission Payable -30,000
in July 1, 20x1. Premiums are paid annually in advance.
8. ABC Co. borrowed P 400,000 for one year on May 1, 7. Prepaid Insurance 24,000
20x1. Interest payment based on annual rate of 12% are 8. Unpaid interest expense -8,000 340,400
made quarterly, beg. With the first payment on Aug 1,
Net Income – Accrual Basis Php 526,000
20x1.
Correction of Errors:

ABC Co.’s year end financial statements contained the following errors

Dec 31, 20x0 Dec 31, 20x1

Ending Inventory 100,000 understated 90,000 overstated
Depreciation expense 20,000 understated -

• Insurance premium amounting to P 75,000 was paid in advance for year 20x0, 20x1 and 20x2. the
same was charged in expense in full during 20x0.

• In Dec 31, 20x1, a fully depreciated machinery was sold for P 160,000 cash, but it was recorded only in
20x2.

• No other errors was noted and no corrections on these were made.

Question: 4. What is the effect of the errors on the company’s
Retained Earnings balance at Dec 31, 20x1?
1. What is the effect of errors in the 20x0 profit? a. Understated 75,000
a. Understated 130,000 b. Understated 50,000
b. Understated 155,000 c. Overstated 110,000
c. Overstated 70,000 d. none
d. none

2. What is the effect of errors on the company’s 20x1 5. What is the effect on the company’s working
working capital? capital at Dec 31, 20x2?
a. Overstated 55,000 a. Overstated 65,000
b. Overstated 30,000 b. Understated 95,000
c. Overstated 215,000 c. Overstated 160,000
d. Understated 45,000 d. none
3. What is the effect of errors on the 20x1 profit?
a. Understated 95,000
b. Understated 70,000
c. Overstated 90,000
d. none
Correction of Errors:

ABC Co.’s year end financial statements contained the

following errors

Dec 31, 20x0 Dec 31, 20x1

Profit Profit WC RE WC
Ending Inventory 100,000 90,000
understated overstated 20x0 20x1 20x1 20x1 20x2
Depreciation 20,000 - 12/31/20x0 Ending
expense understated Inventory (100,000) 100,000 -

• Insurance premium amounting to P 75,000 was paid 12/31/20x0 Depreciation 20,000 20,000
in advance for year 20x0, 20x1 and 20x2. the same 12/31/20x1 Inventory 90,000 90,000 90,000
was charged in expense in full during 20x0.
Insurance Premium (50,000) 25,000 (25,000) (25,000)
• In Dec 31, 20x1, a fully depreciated machinery was
sold for P 160,000 cash, but it was recorded only in Sale of Machinery (160,000) (160,000) (160,000)
20x2.

• No other errors was noted and no corrections on

these were made. Total Effect (130,000) 55,000 (95,000) (75,000) -
Question: 4. What is the effect of the errors on the company’s
Retained Earnings balance at Dec 31, 20x1?
1. What is the effect of errors of 20x0 profit? a. Understated 75,000
a. Understated 130,000 b. Understated 50,000
b. Understated 155,000 c. Overstated 110,000
c. Overstated 70,000 d. none
d. none

2. What is the effect of errors on the company’s 20x1 5. What is the effect on the company’s working
working capital? capital at Dec 31, 20x2?
a. Overstated 55,000 a. Overstated 65,000
b. Overstated 30,000 b. Understated 95,000
c. Overstated 215,000 c. Overstated 160,000
d. Understated 45,000 d. none
3. What is the effect of errors on the 20x1 profit?
a. Understated 95,000
b. Understated 70,000
c. Overstated 90,000
d. none
See you next week!
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