Chapter 20: Audit of Other Accounts in The Statement of Profit or Loss and Comprehensive Income

Chapter 20: Audit of Other Accounts in the Statement of Profit or Loss
and Comprehensive Income
Exercises
Exercise 1
During 20X7, White Company determined that machinery previously depreciated over
a 7-year life had a total estimated useful life of only 5 years. An accounting change was made in
20X7 to reflect the change in estimate. If the change has been made in 20X6, accumulated
depreciation would have been P1,600,000 at December 31, 20X6, instead of P1,200,000. As a
result of this change, the 20X7 depreciation expense was P100,000 greater. The income tax rate
was 30% in both years. What should be reported in White’s statement of profit or loss and
comprehensive income for the year ended December 31, 20X7, as the cumulative effect on prior
years of changing the estimated useful life of the machinery?
a. P 0 b. P 280,000 c. P 300,000 d. P 400,000
Exercise 2
How should a change in accounting estimate that is recognized by a change in
accounting principle be reported?
Change in accounting estimate Change in accounting principle
a. No No
b. Yes Yes
c. No Yes
d. Yes No
Exercise 3
At the beginning of 20X8, Red Company discovered the following errors made in the
preceding 2 years:
2016 2017
Overstatement of ending inventory P 5,000 P 2,000
Omission of wages payable 700 800
Omission of allowance for doubtful accounts 1,300 1,700
Prepayment of insurance recorded as expense 500 200
Reported net income was P27,000 in 20X6 and P35,000 in 20X7. The allowance for
doubtful accounts had a zero balance at the beginning of 20X6. No accounts were written off
during 20X6 or 20X7. Ignore income taxes.
Required:
1. What is the correct net income for 20X6 and 20X7?
2. Prepare the adjusting entry in 20X8 to correct the errors.
Answer:
Requirement (1)
20X7 20X6
Reported net income P 35,000 P 27,000
Subtract ending inventory overstatement (2,000) (5,000)
Add beginning inventory overstatement 5,000
Subtract wages payable when incurred (800) (700)
Add wages payable when expensed 700
Subtract bad debts * P1,700 – P1,300 (400)* (1,300)
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Add back prepayments in year recorded as expense 200 500
Subtract prepayments in year expense is incurred (500) ________
Correct net income P 37,200 P 20,500
Requirement (2)
January 1, 20X8 Retained Earnings 4,300
Insurance Expense 200
Inventory 2,000
Wages Expense 800
Allowance for Doubtful Accounts 1,700
Problems
Problem 1
Rita Cruz, your staff assistant on the April 30, 20 X2, audit of Maxwell Company, was
transferred to another assignment before she could prepare a proposed adjusting journal entry
for Maxwell’s Miscellaneous Revenue account, which she had analyzed per the working paper
given on the next page. You have reviewed the working paper and are satisfied with Cruz’
procedures. You are convinced that all the miscellaneous revenue items should be transferred
to other accounts.
Required:
Draft a proposed adjusting journal entry at April 30, 20X2, for Maxwell Company’s
Miscellaneous Revenue account.
Maxwell Company
Miscellaneous Revenue
Year Ended April 30, 20X2
Account Number: 430 Q-
2
Date Description Reference Amount
May 8, 20X1, Proceeds of sale of scrap from Various CR P 58,430 Y
through April 7, manufacturing process (total of 12
20X2 monthly sales)
July 18, 20X1 Write-off old outstanding checks; GJ 7-4 11,000 Y
numbers 118 – P5,000; 214 – P4,000; 407
– P2,000
September 22, Recovery of previously written off CR 9-1 43,810 Y
20X1 account receivable from Wilson Company
February 6, 20X2 Cash proceeds from sale of machine, Cost CR 2-1 35,000 Y
of P100,000 and accumulated
depreciation of P80,000 as of February 6,
20X2, not removed from accounts.
April 28, 20X2 Refund of premium overcharge on fire Cr 4-1 6,000 Y
insurance policy no. 1856, for period
April 1, 20X2 – March 31, 20X3
April 30, 20X2 Balance per ledger P 154,240
Y - Traced to cash receipts journal or general journal; vouched to appropriate supporting

documents
R.A.K.
May 18,
20X2
Answer:
MAXWELL COMPANY
Proposed Adjusting Journal Entry
April 30, 20X2
Accumulated Depreciation: Machinery 80,000

Miscellaneous Revenue 154,240
Cost of Goods Sold 58,430
Unclaimed Checks 11,000
Allowance for Doubtful Accounts 43,810
Machinery 100,000
Gain on Sale of Machinery (3,500 - 2,000) 15,000
Unexpired Insurance (11/12 x 6,000) 5,500
Insurance Expense (1/12 x 6,000) 500
Problem 2
The Orange Corporation is in the process of negotiating a loan for expansion purposes.
The books and records have never been audited, and the bank has requested that an audit be
performed. Orange has prepared the following comparative financial statements for the years
ended December 31, 20X7 and 20X6:
Statement of Financial Position
As of December 31, 20x7 and 20X6
20X7 20X6
Assets
Current assets
Cash P 163,000 P 82,000
Accounts receivable 392,000 296,000
Allowance for uncollectible accounts (37,000) (18,000)
Trading Securities, at cost 78,000 78,000
Merchandise Inventory 207,000 202,000
Total Current assets 803,000 640,000
Fixed Assets
Property, Plant, and Equipment 167,000 169,500
Accumulated Depreciation (121,600) (106,400)
Total fixed assets 45,400 63,100
Total assets P 848,400 P 703,100
Liabilities and Shareholders’ Equity
Liabilities
Accounts Payable P 121,400 P 196,100
Shareholders’ Equity
Ordinary shares, par value P10, authorized 50,000 shares, 260,000 260,000
issued
and outstanding 20,000
Retained Earnings 467,000 247,000
Total Shareholders’ Equity 727,000 507,000
Total liabilities and shareholders’ equity P 848,400 P 703,000
Statement of Income
For the Years Ended December 31, 20X7 and 20X6
20X7 20X6
Sales P 1,000,000 P 900,000
Cost of Sales 430,000 395,000
Gross Profit 570,000 505,000
Operating Expenses 210,000 205,000
Administrative Expenses 140,000 105,000
350,000 310,000
Net income P 220,000 P 195,000
During the course of the audit, the following additional facts were determined:
1. An analysis of collection and losses on accounts receivable during the past 2 years
indicates a drop in anticipated losses due to bad debts. After consultation with
management, it was agreed that the loss experience rate on accounts receivable should
be reduced from the recorded 9.4% to 5%, beginning with the year ended December 31,
20x7.
2. An analysis of marketable securities revealed that this investment portfolio consistent
entirely of short-term investments in trading securities that were acquired in 20X1. The
total market valuation for these investments as of the end of each year were as follows:
December 31, 20X6 – P81,000; December 31, 20X7 – P62,000.
3. The merchandise inventory at December 31, 20X6, was overstated by P4,000 and the
merchandise inventory at December 31, 20X7, was overstated by P6,100.
4. On January 2, 20X6, equipment costing P12,000 (estimated useful life of 10 years and
residual value of P1,000) was incorrectly charged to Operating Expenses. Orange
records depreciation via the straight-line method. In 20X7, fully depreciated equipment
(with no residual value) that originally cost P17,500 was sold as scrap for P2,500.
Orange credited the proceeds of P2,500 to Property and Equipment.
5. An analysis of 20X6 operating expenses revealed that Orange charged to expenses a 3-
year insurance premium of P2,700 on January 15, 20X6.
Required:
1. Prepare the journal entries to correct the books at December 31, 20X7. The books for
20X7 have not been closed. Ignore income taxes.
2. Prepare a schedule showing the computation of corrected net income for the years
ended December 31, 20X7 and 20X6, assuming that any adjustments are to be reported
on comparative statements for the 2 years. The first items on your schedule should be
the net income for each year. Ignore income taxes. (Do not prepare financial
statements.)
Answer:
Requirement (1)
(1) Allowance for Uncollectible Accounts 17,400
Administrative Expenses (37,000 – 19,600) 17,400
To reflect reduction in loss experience rate.
(2) Unrealized Holding Loss on Trading Marketable Securities 19,000
Valuation Allowance 16,000
Retained Earnings 3,000
To reduce marketable securities to market valuation and correct prior year’s
profit.
(3) Retained Earnings 4,000
Cost of Sales 2,100
Merchandise Inventory 6,100
To adjust for overstatements in opening and closing inventories.
(4)
a. Equipment 12,000
Operating Expenses 1,100
Accumulated Depreciation: Equipment 2,200
To adjust for error in recording of equipment purchase in 2005 and related
depreciation for 2005 and 2006.
b. Accumulated Depreciation: Equipment 17,500
Equipment 15,000
Other Income 2,500
To adjust for misposting of equipment sale.
(5) Prepaid Expenses 900
Operating Expenses 900
To adjust for non-recognition of prepaid expense in 2005 and 2006.
(6) Ordinary Shares 60,000
Capital in Excess of Par 60,000
To adjust for capital contributed in excess of par value.
Requirement (2)
Orange Corporation
Computation of Corrected Net Income
For Years Ended December 31, 2006 and 2005
2006 2005
Debit (Credit) Debit (Credit)
Reported income P(220,000) P(195,000)
Change in accounts receivable loss experience rate (17,400) ---
Unrealized loss (gain) on marketable securities 19,000 (3,000)
Ending merchandise inventories overstated:
December 31, 2005 (4,000) 4,000
December 31, 2006 6,100
Misposting of equipment purchase:
Decrease in operating expenses – 2005 (10,900)
Increase in operating expenses – 2006 1,100
Misposting of proceeds of equipment sold (2,500)
Recognition of prepaid insurance ___ 900 (1,800)
Corrected net income P(216,800) P(206,700)
Problem 3: Correction of Income and Related Accounts

You have been engaged to review the records and prepare corrected financial
statements for the XOR Corporation. The books of account are in agreement with the
following statement of financial position:
XOR Corporation
December 31, 20X7
(In thousands)
Assets
Cash P 5,000
Accounts Receivable 10,000
Notes Receivable 3,000
Inventory 25,000
P 43,000
Liabilities and Capital
Accounts Payable P 2,000
Notes Payable 4,000
Share Capital 10,000
P 43,000
A review of the books of the corporation indicates that the following errors and
omissions had not been corrected during the applicable years:
December Inventory Inventory Prepaid Prepaid Accrued Accrued
31 Over-valued Under-valued Expense Income Expense Income
20X4 P- P 6,000 P 900 P- P 200 P-
20X5 7,000 - 700 400 75 125
20X6 8,000 - 500 - 100 -
20X7 - 9,000 600 300 50 150
The profits per the books are: 20X5, P7,500; 20X6, P6,500; and 20X7, P5,500. No
dividends were declared during these years, and no adjustments were made to retained
earnings.
Required:
Prepare a worksheet to develop the correct profits for the years 20X5, 20X6 and 20X7
and the adjusted statement of financial position accounts as of December 31, 20X7. (Ignore
possible income tax effects)
Answer:
XOR Corporation
Worksheet to Correct Net Profit and Balance Sheet Accounts
From 2005 to 2007
Net Profit Adjustments to Balance Sheet Accounts
Inventory Retained Prepaid Prepaid Accrued Accrue
2005 2006 2007 Earnings Expense Income Expense d
s s Income
Unadjusted P7,500 P6,500 P5,500 P25,00 P27,00 - - - -
Balance 0 0
Add (Deduct)
Adjustments
(1)
Overvaluation
of inventory
2005 (7,000) 7,000
2006 (8,000 8,000
)
(2)
Undervaluatio
n of inventory
2004 (6,000)
2005 9,000 9,000 9,000
(3) Prepaid
Expenses
omitted at end
of year
2004 (900)
2005 700 (700)
2006 500 (500)
2007 600 600 600
(4) Prepaid
income omitted
at end of year
2005 (400) 400
2007 (300) (300) 300
(5) Accrued
expenses
omitted at end
of year
2004 200
2005 (75) 75
2006 (100) 100
2007 (50) (50) 50
(6) Accrued
income omitted
end of year
2005 125 (125)
2007 150 150 150
Adjusted P(5,850 P5,550 P22,50 P34,00 P36,40 P600 P30 P50 P15
Amount ) 0 0 0 0 0
Problem 4
The statement of financial position below is submitted to you for inspection and review.
Sun Freight Company
December 31, 20X7
Assets
Cash……………………………………………………………….. P 45,050
Accounts Receivable……………………………………………… 112,500
Inventories………………………………………………………… 204,000
Prepaid Insurance………………………………………………... 8,800
Land, Buildings, and Equipment……………………………….. 376,800
P 747,150
Liabilities and Owners’ Equity
Miscellaneous Liabilities…………………………………………. P 3,600
Loan Payable……………………………………………………… 76,200
Accounts Payable…………………………………………………. 75,250
Share Capital……………………………………………………… 215,000
Paid-in Capital……………………………………………………. 377,100
P 747,150
In the course of the review, you find the data listed below:
a. The possibility of uncollectible accounts on accounts receivable has not been considered.
It is estimated that the uncollectible accounts will total P4,800.
b. P45,000 representing the cost of a large-scale newspaper advertising campaign
completed in 20X7 has been added to the inventories, since it is believed that this
campaign will benefit sales of 20X8. It is also found that inventories include
merchandise of P16,250 received on December 31 that has not yet been recorded as a
purchase.
c. The books show that land, buildings, and equipment have a cost of P556,800 with
depreciation of P180,000 recognized in prior years. However, these balances include
fully depreciated equipment of P85,000 that has been scrapped and is no longer on
hand.
d. Miscellaneous liabilities of P3,600 represent salaries payable of P9,500, less noncurrent
advances of P5,900 made to company officials.
e. Loan payable represents a loan from the bank that is payable in regular quarterly
installments of P6,250.
f. Tax liabilities not shown are estimated at P18,250.
g. Deferred income tax liability arising from temporary differences totals P44,550. This
liability was not included in the statement of financial position.
h. Share capital consists of 6,250 shares of preference 6% share, par P20 and 9,000
ordinary shares, stated value P10.
i. Share capital had been issued for a total consideration of P283,600, the amount received
in excess of the par and stated values of the shares being reported as paid-in capital.
j. Net income and dividends were recorded in paid-in capital.
Required:
Based on the above information, compute for the following:
1. Accounting receivable (net):
a. P107,700 b. P112,500 c. P114,500 d. P113,000
2. Land, buildings, and equipment (net):
a. P378,800 b. P556,800 c. P376,800 d. P386,800
3. Inventories:
a. P204,000 b. P198,000 c. P159,000 d. P195,000
4. Total current assets:
a. P320,000 b. P330,550 c. P310,250 d. P312,450
5. Current portion of long-term debt:
a. P25,000 b. P51,200 c. P0 d. P76,200
6. Preference shares:
a. P215,000 b. P90,000 c. P125,000 d. P68,800
7. Paid-in capital in excess of par and stated value:
a. P68,600 b. P90,000 c. P377,000 d. P87,000
8. Retained Earnings:
a. P180,000 b. P190,650 c. P180,650 d. P179,650
9. Total assets:
a. P703,250 b. P705,250 c. P710,250 d. P703,000
10. Total current liabilities:
a. P114,250 b. P134,250 c. P138,375 d. P200,000
Answer:
1. a P107,700 (P112,500 – P4,800)
2. c P376,800
3. c P159,000 (P204,000 – P45,000)
4. a P320,550
5. a P25,000
6. c P125,000
7. a P68,600
8. d P179,650
9. a P703,250
10. a P144,250 (P9,500 + P25,000 + P16,250 + P18,250 + P75,250)
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Chapter 20: Audit of Other Accounts in The Statement of Profit or Loss and Comprehensive Income

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Chapter 20: Audit of Other Accounts in the Statement of Profit or Loss

and Comprehensive Income

Y - Traced to cash receipts journal or general journal; vouched to appropriate supporting

Accumulated Depreciation: Machinery 80,000

Problem 3: Correction of Income and Related Accounts

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