Chapter AUDIT OF OTHER ACCOUNTS IN THE STATEMENT OF PROFIT OR LOSS AND COMPREHENSIVE INCOME Expected Learning Outcomes After studying this chapter, you should be able to: 1. Describe the auditors objectives for the substantive audit of account in the statement of profit or loss and comprehensive income. 2. Describe the nature of the audit procedures to accomplish the auditors’ objectives for the audit of accounts in the statement of profit or loss and comprehensive income. 3. Understand and prepare audit working papers to document audit procedures for the accounts in the statement of profit or loss and comprehensive income. Bogs ‘Seana wth CamS:anerCHAPTER 20 AUDIT OF OTHER ACCOUNTS IN THE STATEMENT OF PROFIT OR LOSS ANp COMPREHENSIVE INCOME INTRODUCTION Investors and other users of financial statements rely on the Statement Of Income as an indication of a company's performance for a given period. They often information from this statement as a guide in projecting expected future performance. The auditor must therefore have a reasonable basis for expressing an opinion on the fairness of management's statement of profit or loss ang comprehensive income, representations and disclosures. . This Chapter presents the approach and procedures that the auditors use in examining the client's statement of profit or loss and comprehensive income accounts. AUDIT OBJECTIVES ‘The objectives (assertions) in the audit of revenue and expenses are: I. To determine whether all (completeness) revenues and expenses (rights and obligations) applicable to the audit period (occurrence) have been recognized and are matched properly (allocation) in accordance with generally accepted accounting principles. 2. To determine whether all material unusual and infrequent items are segregated properly in the statement of profit or loss and comprehensive income (presentation). 3. To determine whether revenues and expenses are classified properly and consistently (presentation), +. To determine whether disclosures concerning revenue and expense 8 adequate and in accordance with financial reporting stand (disclosure), ‘Scand wihCamS:anerEXPENSES are: Audit of Other Accounts .._ 595 AUDITOR'S APPROACH IN THE EXAMINATION OF REVENUES AND Normally, very few explicit tests of balances in the revenuc and expense accounts are conducted at the end of an audit engagement. Instead, the auditor will have compliance tests of the various segments of the information proce: system (revenue and collection cycle, expenditure cycle, cycles) and will have also gathered substantive evidence to support the propriety of revenue and expense information during the period. Furthermore, may substantiate the balances in a number of these accounts as a by- the substantive audit work for the related asset and li ssing financing and investing the auditor product of ability accounts. Examples Asset / Liability Accounts Statement of Profit or Loss and | Comprehensive Income Accounts Cash Sales, Sales Discount, Dividend / Interest Income — Expenses (eg. salaries, transportation, etc.) ‘Accounts Receivable Sales, Sales Retums, Bad Debts Expense Notes Receivable Interest Income. Marketable Securities and other investments Dividend / Interest Income, Gain (Loss) on Sale of Marketable Securities, Unrealized Loss (Gain) on Marketable Securities Inventories Purchases and Cost of Sales Property and Equipment Depreciation Expense, Repairs and Maintenance Expense, Gain (Loss) on Sale of Equipment Prepaid Expenses; Deferred Charges Rent Expense, Insurance Expenses and other related expenses ‘Amortization, Royaities Expense Intangibles Accounts Payable Purchases, Purchase Retums, Purchase Discount Wages Expense, Commission Expense, Accrued Payables Taxes Notes Payable Interest Expense Mortgage / Bond Payable Interest Expense _| ‘Seana wth CamS:aner$96 Chapter 20 balances in the revenue and expense accounts .d, the auditor however needs to suppl ate ssts with the following procedures. rent Although formal tests of the frequently not necessary at year-en the evidence obtained in the foregoing te 1. Analytical review of operations 2. Account analysis The above procedures are also appropriate for other expenses not verified jn the audit of statement of financial position accounts. SUBSTANTIVE PROCEDURES FOR SELLING, GENERAL AND ADMINISTRATIE EXPENSES To get additional evidence about the reasonableness of eNpense accounts, iy following substantive tests are appropriate: 1. Perform analytical procedures related to the accounts. a. Develop an exception of the account balance. ‘Auditors develop an expectation of the account balance by Considering factors such as budgeted amounts, the prior-year audited balance industry averages, relationships among financial data, and relevan nonfinancial data. Comparison of expense (as well as revenue) accounts with industry and nonfinancial data is another means of bringing to light circumstances tha require investigation. The auditors also may examine relationships between financial and nonfinancial information, such as between production records stated in gallons or pounds and the dollar amounts of sales. b. Determine the amount of difference from the expectation that can be accepted without investigation The auditors use their estimates of materiality to arrive at which differences are to be investigated and which might be expected to occur by chance. However, the extent of the assurance desired from the analytical procedure also should be ¢onsidered. cc. Compare the company's account balance with expected account balance Comparisons of the expense accounts with expected amounts may reve! significant differences that warrant investigation. _—d ‘Seanad wth ComsatAudit of Other Accounts ..__$97 d__ Investigate significant deviations from the expected account balance The starting point for investigating significant variations in expenses generally is inquiry of management. The auditors substantiate management's explanations for significant variations by various means, including analyses of accounts. 2. Review journals and ledgers for unusual items that may be indicative of misstatements entries, amounts, and other items lence about expense accounts. ly large entries, entries from Reviewing journals and ledgers for unusual is an effective way of obtaining additional evid The auditors will look for items such as unusua unusual sources, and entries with unusual timing. 3. Obtain or prepare analyses of selected expense accounts mine the most important jong those considered in legal expenses and and (5) rents and Although the circumstances of the engagement dete expense accounts, the following are frequently ame detail: (1) advertising, (2) research and development, (3) other professional fees, (4) maintenance and repairs. royalties. 4. Obtain of prepare analyses of critical expenses in income tax returns Income tax returns generally require schedules for officers’ salaries. directors’ fees, taxes, travel and entertainment, contributions, and casualty losses. In addition to these, officers’ expense account allowances are presented in the analysis of officers’ salaries. Accordingly, the auditors should obtain or prepare analyses of any of these expenses that were not analyzed when performing other audit steps. ANALYTICAL REVIEW OF OPERATIONS The auditor generally places heavy emphasis on analytical review procedures in the revenue and expense area. In its simplest form, the rev iew of operations consists of comparing the statement of profit or loss and comprehensive income for the year being audited with the budget for the year and the actual amounts for the prior year and determining the underlying reasons for significant variations or the lack thereof. ‘Seana wth CamS:aner508 Explanation for significant variations are obtained first from the client then verified by examination of supporting evidence. For example, the fa ‘One| in sales can be explained by the sales manager, whereas the significant cht repairs and maintenance can best be explained by the plant oF main supervisor. n The auditor should also compare operating statistics such as the gross Percentage, inventory tumover. receivable tumover, operating ratio significant relationships with statistics of prior year and for other ent the same business. Such comparisons and review of operations m improper classification of extraordinary charges or credits as operat oF erroneous recording of major repairs and maintenance expense. Profit nd other Srprises in ay indicate IMB Expenses The analytical review of operations will also include comparison of revenue an expense account balances with budgeted amounts. Significant variations betyens the actual amount budgeted amounts may indicate that operations Were not conducted in accordance with the company’s predetermined plans. The autig can obtain the explanations of such variances from the client's management, ACCOUNT ANALYSIS The auditor often will analyze certain selected operating accounts to supplement the information already obtained elsewhere. Analysis is usually required for accounts that (1) require special disclosure in the statement of profit or loss and comprehensive income, (2) contain information needed in preparing tax retums and reports to SEC, and (3) general account titles that suggest the likelihood of misclassifications and errors. Accounts generally requiring analysis are: Salaries and wages Contributions Taxes, licenses and fees Advertising Rents and royalties Travel and entertainment Legal and professional fees Miscellaneous expense Maintenance and repairs Interest expense ‘Seanad wth ComsatAudit of Other Accounts ..._ 599 ° tents will usually follow the general guidelines listed below once pal perating account has been selected for detailed analysis: 1. Understand the purposes of the particular analysis and the number and kinds of items to be checked. ° For example: (1) salaries and wages are analyzed to countercheck proper withholding of taxes. (2) repairs and maintenance = for verification of capital items charged to expense, (3) rents ~ for identification of lease liabilities, (4) legal expenses ~ for verification of contingent liabilities and (5) miscellaneous expense ~ because it is often the repository of unusual charges and expenses. 2. Review the general ledger account. 3. Whenever possible, have the clients’ employees prepare the a schedules. 4, Examine supporting documents such paid checks — when appropriate. nalysis as invoices, contracts, agreements, Figure 20-1 illustrates the Analysis of the Professional Fees Expense Figure 20-1: Analysis of the Professional Fees Expens® XCorpary Protessional Fees Expense 1231.X7 ems Amount Descnption Date Voucher 35X7 3125 Cavera& Co. CPAS P19.000 v Retainer for list quarter 37X7 3136 Cruz & Co, Attorneys 8,000 v __Relainer for first quarter. BATX? «F217 Cuz Co, Atorneys 9,750 v Representation in patent infringement suil © | eee mam ¥ oo) Balance per ledger Traced 0 general edger. % smined propery aperoved voucher mih supporting invoice rom atone and canceled check. © Coningent ably. See letter irom attorney evaluating the potential abit ‘Noted for disclosure in financial stalemenis Column fected Prepared by Renewed by Tata [Date _| tial [| Cate ‘Seana wth CamSsaner ®600 Chapte CLASSIFICATION DISCLOSURE The auditor must be alert to transactions involving revenue and €xpenses thay require special classification or disclosure. Examples include the classin losses from discontinued operations, gains or losses, and errors affea period. He should also be satisfied with the level of summarization of and expense accounts in the statement of profit or loss and comprehensi income: for example, that all significant accounts are shown separately ana insignificant accounts are aggregated. ol will ication gf ting rig he revenue Illustrative Audit Case 20-1: Preparation of Audited Statement of Profit or Loss and Comprehensive Income Presented below is information concerning the results of operations of Lawag Corporation for the calendar year: Cost of goods sold P2,985,000 Administrative expenses 1,300,000 Gain on the sale of trading securities 15,000 Loss on sale of discontinued segment of business 95,000 Interest expense 65,000 Selling expense 1,343,000 Sales 8,650,000 Loss on sale of plant assets 25,500 Correction of error (loss) in previous year's income, due to capitalization of research and development costs 76,000 The following additional information is available: 1. All income items are subject to a 35% income tax rate except the loss on disposal of a segment of the company's operations, which is subject to a 20% income tax rate. 2. The company had 1,000,000 ordinary shares outstanding from January | 10 June 30, when an additional 200,000 shares were sold. There was no other share activity during 20X7. 3. The following amounts related to the disposed segment are included in the appropriate revenue and cost figures: Sales P750,000 Cost of goods sold 600,000 Selling expenses 100,000 Administrative expenses 350,000 Interest expense 10,000 iad ‘Scand wth CamSsanerAud of Other Accounts WON Require a. Prepare a statement of profit or loss and comprehensive income for Lawag, Corporation for the year ended December 31. 20X7. b. Comment on why income items, such as the components of discontinued operations, are presented in the statement of profit, or loss and comprehensive income on a net-of-tax basis: Solution: Mustrative Audit Case 20-1 Requirement (a) Lawag Corporation Statement of Profit of Loss and Comprehensive Income For the Year Ended December 31 20X7 Sales 7.900.000 Cost of Goods Sold 2,385,000 Gross profit §,515,090 Operating expenses Administrative P 960,000 Selling 743,000 2,492,090 Operating income 3,322,000 Other revenues and expenses interest expense P 55.000 Loss on sale of piant assets 25,500 Gain on sale of marketable securities _ (45.000) 65,500 Income before income tax 3,256,500 Income tax expense (35%) 1.139.775 Income from continuing operations 2.116.725 Discontinued operations Operating loss of discontinued segrent net of P108,500 income tax P 201,500 Loss on disposal of discontinued segment ret of P19,000 income tax Net income Earnings per ordinary share Income fram continuing operations Discontinued operations Net income ‘Seana wth CamS:aner602 Chapter 20 Computations: Sales (P8,650,000 - P750,000) Cost of goods sold (P2,985,000 - P600,000) Administrative expenses (P1,300,000 - P350,000) Selling expenses (P1,343,000 - P100,000) Interest expense (P65,000 - P10,000) Income tax expense (P3,099,500 x 35%) EERE Operating loss on discontinued operations: Sales P750,000 Cost of goods sold (600,000) Administrative expenses (350,000) Selling expenses (100,000) Interest expense ( 10,000) Loss before income tax (310,000) Income tax (P310,000 x 35%) 201,500 Tax on loss disposal of segment: (P95,000 x 20%) P 19,000 Eamings per share: Weighted average ordinary shares outstanding (1,000,000 shares x 6 months) 6,000,000 (1,200,000 shares x 6 months) 7,200,000 13,200,000 + 12 1,100,000 EPS: Income from continuing operations (P2,116,725/1,100,000) pis? Discontinued operations (P277,500/1,100,000) Ba Net income (P1,839,225/1,100,000) PLst Requirement (b) Special items, such as discontinued operations, are presented on a net-of 18 basis in order to isolate their full financial impact in a single income item. TM permits the income subtotals to be unaffected by the item that is speci | classified. If the tax effect of the specially classified item were included it income tax expense figure. relationships within the statement of profit or loss an comprehensive income would be distorted. ‘Seanad wth ComS:anerAudit of Other Accounts ..__603 IMustrative Audit Case 20-2: Pi i it Adj vicancial Statements reparation of Audit Adjustments and Audited Jay Corporation was incorporated ‘on December 1, 20X6, and began operations | cid later. Before closing the books for the fiscal year ended November 30, 20X7, Jay’s controller prepared the following financial statements: JAY CORPORATION Statement of Financial Position November 30, 20X7 x Aysers Current assets Cash P 130,000 Marketable securities, at cost 60,000 Accounts receivable 450,000 Less: Allowance tor doubtful accounts (59.000) Inventories 430,000 Prepaid insurance _i3,000 Total current assets 1,046,000 Property. plant. and equipment 426,000 Less: Accumulated depreciation (40.000) ‘000 Research and development costs Total Assets Liabilities und Shareholders’ Equity I eS 7 7 Fe ee Current liabilities ‘Accounts payable and accrued expenses P 592.00 168,000 Incame taxes payable ; Total current liabilities P_760,000 Shareholders’ equity Ordinary share capital, P10 par value P 400,000 Retained earnings 392,000 Total shareholders’ equity P_792,000 Total Liabilities and Shareholders” Equity 1.552.000 ‘Seanad wth CamS:anerJAY CORPORA HON Statement of Income Ended November 30, 20X7 Net sales Operating expenses Cost of sales PL.670.059 Selling and administrate «oom Depreciation 40.0% Research and development 3010 Total expenses Income before income taves Income tay expense Net income Jay Corporation is in the process of negotiating a loan for expansion purposes, and the bank has requested audited financial statements. During the course of the audit. the following additional information was obtained: 1) The investment portfolio consists of short-term investments in trading securities with a total market valuation of P55,000 as of November 30, 20X7. 2) Based on an aging of the accounts receivable as of November 30, 20X7, it was estimated that P36,000 of the receivables will be uncollectible. 3) Inventories at November 30, 20X7, did not include work-in-process inventory costing P12,000 sent to an outside processor on November 29. 20X7. 4) A P3,000 insurance premium paid on November 30, 20X7, on a policy expiring | year later was charged to insurance expense. 5) Jay adopted a pension plan on June 1, 20X7, for eligible employees tb administered by a trustee. Based upon actuarial computations, the first 12 months' accrued pension plan expense was estimated at P45,000. 6) On June 1, 20X7, a production machine purchased for P24,000 ws charged to repairs and maintenance. Jay depreciates machines of this SPF on the straight-line method over a 5-year life, with no salvage value. financial and tax purposes. ud ‘Seanad wth CamS:anerAudit of Other Accounts 605 7) Research and development costs of P150,000 were incurred in the development of a patent that Jay expects to be granted during the fiscal year ending November 30, 20X8. Jay initiated a 5-year amortization of the P150,000 total cost during the fiscal year ended November 30, 20X7 During December 20X7 a competitor company filed suit against Jay for patent infringement claiming P200,000 in damages. Jay's legal counsel believes that an unfavorable outcome is probable. A reasonable accrual based on an estimate of the court's award to the plaintiff is P50.000. 9) The 30% effective tax rate was determined to be appropriate for calculating the provision for income taxes for the fiscal year ended November 30, 20X7. Ignore computation of deferred portion of income taxes. 8) Required: 1. Prepare the necessary correcting entries. sition of Jay November 30. 2. Prepare a corrected statement of financial po 0, 20X7. 20X7, and a corrected statement of income November 3! Solution: Mustrative Audit Case 20-2 Requirement (1) ad debts) 23.000 alance delerancd by aging 0! 3) Inventories 2.000 Cost ut Sales To adust ‘or workin-process inventory 7#¢ by processor ; ‘Seana wth CamS:aner600 Chapter 20 Prepad Insurance Seling and Administrative Expenses (insurance) 300) To adjust for noarecogniion of prepaid expense. : ‘ (5) Seling and Admin stative Expenses (2ension) 22,500 Accounts Payable and Accrued Expenses 2255 To accive pension expense (P45,000 x 6/12). 6 Property, Plant and Equipment 24,000 Depreciaon Expenses 2.400 Cost of Sales (repairs & maintenance) 24000 Accumulated Deoreciation 2400 To adjust for crarge to repars and maintenance of machine purchased on 6/1/17, and to record depreciation to 11/30/17 (P24,000 x 20% x 6/12) a Reseach and Devolopnent Expense 120,000 Rosearch and Development Costs 120000 To write off research ard development costs in accordance with PASIPERS (8 Estimated Loss iron Lawsuit 50,000 Estimated Liabl ly from Lawsuit 0,000 To record oichable damages payable re: lawsuit for patent infengement Income Taxes Payable 41,370 Income Tax Expense 44,370 To adjust provision for year ended 11/30/17 (Schedule 1) ‘Seana wth CamS:anerr jule 1 Adjustment lo Income Tax Expense -- Year Ended November Reduction in allowance Unadjusled income before income taxes ‘Add: Adjustments increasing income for doubthul accounts Work-in-process inventory al outside processor Recognition of prepaid insurance Revarsal of 6/1/X7 charge to repairs and maintenance Pensioit expense Depreciation on machine purchased 6/1/X7 Research and development expense Estimated loss from lawsuit Requirement (2) Deduct’ Acjustmants decreasing income Unrealized loss on trading securities Adjusted income before income taxes Effective income tax rate ‘Adjusted income tax expense Income tax expense per books ‘Adjustment to reduce income tax expense JAY CORPORATION Audit of Other Accounts — 7] P 23,000 12,000 3,000 24,000 P 5,000 22,500 2,400 120,000 50,000 Statement of Financial Position [Current assets Cash Marketable securities, al cost Less’ Allowance for reduction to market Accounts receivable Less Allowance for doubiful accounts Inventories Prepaid insurance Total current assets Property, plant. and equipment Less: Accumulated depreciation Total Assets November 30. 20X7 Assels P 69.000 —{5.000) 459.000 [36,000) 450,000 42.400) 30 20X7 607 580,000 62,000 P622,000 199.900 422,100 x__ 30% 126.630 168,000 141.370) P 150,000 55.000 414,000 442.000 18,000 P1,079,000 ‘Seana wth CamS:aner608 Chapt rr Liabilities and Shareholders’ Equity Current abies Accounts payable and accrued expenses P tea Estimated iabibty from lawsui 500 Income taxes oayable 1654 Tetal current PRET Shareholders’ ea1 Ordinary share capital P anny Retained earnin 295.4) Total snarehelders' equity 5 69527 Total Lizbiites end Shareholders’ Equity P1865 JAY CORPORATION St cr Loss and Comprehensive Income ar Ended November 30. 20X7 Net sales sate ng expenses Operating incom Less. Cther charges 3d loss on trading securities toss from lawsuit @ income taxes ome laxes ‘Seanad wth CamSsanerAudit of Other Accounts ...__ 609 EXERCISES AND PROBLEMS Exercises Exercise 1 During 20X7, White Company determined that mach'nery 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 1,600,000 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. PO c. 300,000 b. P280,000 d. P400,000 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 ¢ No Yes d. Yes No ‘Seana wth CamS:aner610 Chap At the beginning of Red Company discovered the Following erg made in the preceding 2 years: | 2076 | “Overstatement of ending inventory P5,000 ‘Omission of wages payable 700 -Oinission of allowance for doubitl accounts _ 41,300 500 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 20x No accounts were written off during 20X6 or 20X7. Ignore income taxes, Required. 1, What is the correct net income for 20X6 and 20X72 2. Prepare the adj ing journal entry in 20X8 to correct the errors Problems Probl Rita Cruz, your staff assistant on the April 30, 20X2, audit of Maxwell Company, was transferred to another assignment before she could prepare 4 proposed adjusting journal entry for Maxwell's Miscellaneous Revenut account, which she had analyzed per the working paper given on the nex page. You have reviewed the working paper and are satisfied with Cruz’ procedures, You are convinced that all the miscellaneous revenue item’ should be transferred to other accounts. Required: 7 Draft a proposed adjusting journal entry at April 30, 20X2, for Maxw® Company's Miscellaneous Revenue account ‘Seana wth CamSsanerAudit of Other Accounts 61 ‘Maxwell Company eerie Revenue fear End i Acct. No. 430 jer ced Apa 30,20%2 Q2 Date ‘Description Reference | Amount May 8, 20X1, | Proceeds of sale ‘of scrap from | Various CR | P58,430Y through manufacturing process (total of 12 April 7, 20X2 monthly sales) ‘July 18, 20X1 Write-off old outstanding checks; nos. GJ 7-4 11,000 Y 418 -P5,000; 214 - P4,000; 407 - P2,000 Sept. 22, 20X1 | Recovery ‘of previously written off | CR9-1 43,810 Y account receivable from Wilson Company Feb. 6, 20X2 Cash proceeds from sale ‘of machine. | CR 2-1 35,000 Y Cost of P100,000 and accumulated depreciation of P80,000 as of Feb. 6, 20X2, not removed from accounts. April 28, 20X2 Refund of premium overcharge on CR4-1 6,000 Y fire insurance policy no. 1856, for period April 1, 20X2 - Mar 31, 20X3 April 30, 20X2 Balance per ledger 154,240 Y- Traced to cash receipts journal or general, |journal, vouched to appropriate supporting documents. RAK May 18, 20X2 ‘Seana wth CamS:anerProblem 2 The Orange Corporation isin the process of negotiating a loan for expen purposes, The books and records have never been audited, and the bang” requested that an aut be performed. Orange has prepared the fog comparative financial statements for the years ended December 3}, 20x79 20X6: Statement of Financial Position Aso Hecember $1. 20X7 and 20X6 ~ -_— ae 3 Cash P163.000 P X.009 | Accounts receivable 392,000 2.00 | Allowance for uncollectible aecounts: (37.000) (18.000) | Trading securities. at cost 78,000 78.000, | Merchandise inventory 207,000 202,00 | Total current assers S030 640,000 Vined aysets, ~ | Property, plant and equipment 167.000 169.500 | Avcumulated depreciation (21,000) 106,100) Total fixed assets —AS00, Vourl assets. PRAS, Lévtbilaties anid Shrarcholelors” Lagteaty Liabilities Accounts pay able PLZ L400 Shareholders’ equity Ordinary shares. par value P10, authorized 50,000 shares, issued and outstanding, 20.000 shares, 260.000 260,000 Retained earnings 167,000 247,000 Foul shareholders’ equity 727,000 307,000) S00 £703,100 Fatal liabilities and sharehollers’ equity Statement of Income SIended December 31 24 ind 20X6 7 20X68 Sales Pravneo0 900,08 Cost ot sales 430,000 000 Gross pret 370.000 Operating expens 210,000 Adounistrative expenses 149,000 350,000 Net income b 230.000 | ‘Seanad wth CamS:anerAudit of Other Accounts... O43 During the course of the audit, the following additional facts were determined: 1. An analysis of collections and losses on accounts receivable during the past 2 years indicates a drop in anticipated losses due to bad debts: Afier 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. Rp An analysis of marketable securities revealed that this investment portfolio consisted 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 expense 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.) (AICPA adapted) ‘Seana wth CamS:aneraf Income and Related Accounts You have been engaged to review the reconls and prepare corrected statements for the NOR Corporation, The books of account are in age with the follow ing statement of financial position: Bremen pe tol Financial Position 44, 20X7 Cast \ " P So) ws ore 10.00] is biol Inventory San] PL 000 Livhitities annd Capital P Dow X Lo 10.0 es 2 yay) Pasay A review of the books of the corporation indicates that the following errs and omissions had not been corrected during the applicable years: pone 7% ws | 10 > | | i ww 20X6, P6,S00; and P5.500. No dividends were declared during these years, and no adjustmees were made to retained earnings. Required: Prepare a worksheet to develop the correct profits for the years 20X5. and 20X7 and the adjusted statement of financial position accounts 3 ° e tay elects) (AICAPA Adapt 20Ne ‘Seanad wth CamS:aner[ Audit of Other Accounts 61S Problem 4 The statement of financial position below is submitted to you for inspection and review. ¢ Company Statement of Financial Position’ December 31. 20X7 Assets Cashin cee — pr 45.050 112.500 204,000 8.800 Accounts receivable |... Inventories Prepaid insurance coe Land. buildings, and equipment ....... Liabitines and Qwnees bayuits Miscellaneous liabilities Loan payable . Accounts payable... Share c 3 P7A7.150 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 uncollectible accounts will total 4,800. b, 45,000 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. ¢. The books show that land, buildings, and equipment have a cost of 556,800 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. ‘Seanad wth ComsatEN e. Loan payable represents a loan from the bank that is payable in quarterly installments of P6,250. f. Tax liabilities not shown are estimated at P18,250. Deferred income tax liability arising from temporary differences ton P44,550. This liability was not included in the statement of Financi position. h, Share capital consists of 6,250 shares of preference 6% share, par pq and 9,000 ordinary shares. stated value P10. i, Share capital had been issued for a total consideration of 283,600, the 616 Chapter 2 "eBulay 1" amount received in excess of the par and stated values of the share 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. PI12,500 ec. P114,500 d. P113,000 2. Land, buildings, and equipment (net): a. P378.800 b. P556,800 cc. 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. PO 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 dd. P87,000 8. Retained earnings: a P180,000 b. P190,650 c. P180,650 —d._:PI79,650 9. Total assets: a 703,250 b. P705,250 ce. _P710,250 d. 703,000 10. Total current liabilities: @ PI14.250 — b. P134,250c,_P138,375 4, P200,000 ‘Seana wth CamS:aner