CHAPTER 10 ACCOUNTING CHANGES TECHNICAL KNOWLEDGE To identify the categories of accounting change. To understand the cone ept of a change in accounting estimate. To know the recognition and reporting of change in accounting estimate. To understand the concept of a change in accounting policy. To know the recognition and reporting of a change in accounting policy. To know the guideline when selecting accounting policy in the absence of accounting standard. To understand the concept of prior period errors. To know the recognition and reporting of prior period errors, 271 Sezers of accounting change Categorie: i i timate a. Change 12 accounting estil b cane in accounting policy nting changes can rnings- have a great impact on an entit, ‘y's Accow reported ea important that users of financig) he nature and effect of accounti ti ly on the bottom line which Thus, it is critically statements understand tl changes an must not rely sole! the net income or loss. Change in accounting estimate, PAS 8, paragraph 5, defines a change in accounting estimate as "an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an the-assessment of the present status asset that results from and expected future benefit and obligation associated with the asset and liability". a change in accounting estimate is a normal tion or adjustment of an asset or liability sult of the use of an estimate. an essential part of the s not undermine Simply stated, recurring correct which is the natural re The use of reasonable estimate is preparation of financial statements and doe: their reliability. ‘An estimate may need revision if changes occur regarding the circumstances on which the estimate was based or as a result of new information, more experience or subsequent development te does fan error. By very nature, the revision of the estima not relate to prior periods and is not a correction ©: Jhange in accounting A change in measurement basis is a Cc! policy and not a change in accounting estimate. Pomel mies it is difficult to distinguish a change" accounting ate and. a change in accounting policy. ins in suelte case, the change is treated as a change in accouns ate, with appropriate disclosure. 272 ——Examples of accounting estimate As a result of the uncertainties items in financial statements put can only be estimated. 8 in business activiti les, many cannot be measured with precision Betimation invalves fudgment based on the latest available and relia ion. Estimate. i ee 8 may be required for the Bad debts Loe obsolescence c. Useful life, residual value, and expected consumption of benefit of depreciable eset aes d. Warranty cost e. Fair value of financial assets and financial liabilities yp How to report change in accounting estimate The effect of a change in accounting estimate shall be recognized.currently and prospectively by including it in income or loss of: a. The period of change if the change affects that period only. o z b. The period of change and future periods if the change affects both. To the extent that a change in accounting estimate gives rise to changes in assets and liabilities, or relates to item of equity, it shall be recognized by adjusting the carrying amount of ity in the period of change. the related asset, liability or equil g estimate shall not be accounted A change in an accountin: n ted in financial statements of for by restating amounts repor' Prior periods. Changes in accounting estimates are to be handled currently and prospectively, if necessary. Prospective recogniti f the effect of a change in accounting gnition Oo! k ; . estimate means that the change 18 applied to transactions, other events and conditions from the date of change in estimate. 273Illustration ae . t costing P500,00q ; a depreciable asse P500,000 jg i . At the beginnin, is have a life of 5 years. eof dian ee the original life is changed to 8 years. Thus, a asset has a remaining life of 6 years. For example, i depreciation. Inste. cedure is not to correct past ad, the baat hig carrying amount of P300,000 (P500,000 minus 200,000 depreciation for 2 years) is now allocated over ¢ years or a subsequent. annual depreciation of P50,000. Thus, the entry to record the annual depreciation, starting the third year is: Depreciation 50,000 Accumulated depreciation 50,000 Change in depreciation method A change in depreciation method is accounted for as a change in accounting estimate. Illustration An entity decided to change from the sum of years’ digit method to the straight line method of depreciation on January 1, 2016. The asset originally has a cost of 1,000,000, acquired on January 1, 2014 and is estimated to have @ four-year life. The carrying amount of the asset on January 1, 2016 is determined as follows: Cost 1,000,000 Accumulated depreciation: 4 (4/10 x 1,000,000) 000, 400,000 2015 (3/10 x 1,000,000) 300,000 700,008 Carrying amount 2 ~ January 1, 2016 30087 , =—— v pout he proc ‘ P00 Oe th simply to allocate the carrying amount cpreciation 2 the Temaining life of 2 years using tHe Ty, the depreciation od which is the straight line. Accordiné™ ton for 2016 ig recorded as follows: Depreciation (400, 2 Accumula 000 / 2) 000 ted depreciation 150,00! 150,000 274Accounting policies Accounting policies are th conventions, rules and preparing and presentin, € specific principles, bases, Practices applied by an entity in ig financial statements. Accounting policies are essential for a proper understanding of the information contained in the financial statements. An entity is required to outline all significant accounting policies applied in preparing financial statements. Under accounting standards, alternative treatments are possible. In this case, it becomes all the more important for an entity to clearly state the accounting policies used in preparing financial statements. The entity shall select and apply the same accounting policies each period in order to achieve comparability of financial statements or to identify trends in the financial position, perfermance and cash flows of the entity. e Change in accounting policy Once selected, accounting policies must be applied consistently for similar transactions and events. A change in accounting policy shall be made only when: a. Required by an accounting standard or an interpretation of the standard. more relevant and faithfully about the financial position, d cash flows of the entity. b. The change will result in represented information financial performance an 275Examples of change in accounting policy Xi . nting policy arises when an entity adopts : SO ated Eeoantiog principle which ig different Rom'the one previously used by the entity. Examples of change in accounting policy are: a. Change in the method of inventory pricing from the FIFO * to weighted average method. b. Change in the method of accounting for long term construction contract from cost recovery method to percentage of completion method. c. The initial adoption of policy to carry assets at revalued amount is a change in accounting policy to be dealt with as revaluation in accordance with PAS 16. d. Change from cost model to fair value model in measuring investment property. e. Change to a new policy resulting from the requirement of a new PFRS. The following are not changes in accounting policy: a The application of an accounting policy: for events or transactions that differ in suostance from previously Occurring events or transactions. : b. The application of a new acc i i ‘ts or - is r Ounting policy for events transactions which did not occur previously or that were immaterial How to report a chan; A change in counting po) interpretation Shall b transitional Provisio, Zein accounting policy licy required by a standard or an © applied in accordance with the ns therein, YS the op. 5 : prone standard or interpretation contains no transitional the change a A Bing policy is changed voluntarily» e ¢ i . retroactively,” all be applied restropectively © 276Retrospective application Retrospective application is a to transactions, other events had always been applied. PAS 8, paragraph 22, provides that "; i j the opening balance of each affected component of equity ie the earliest prior period presented and the comparative amounts disclosed for each prior period presented as if the new policy had always been applied." PPlying a new accounting poli ne ig policy and conditions as if that policy Simply stated, retrospective application means that any resulting adjustment from the change in accounting policy shall be reported as an adjustment to the opening balance of retained earnings. 4 The amount of the adjustment is determined as of the beginning of the year of change. However, the adjustment may be made to another component of equity, not retained earnings, in order to comply with another standard. If comparative information is presented, the financial statements of the prior period presented shall be restated to conform with the new accounting policy. The impact of the new policy on the retained earnings prior to the earliest period presented shall be adjusted against the opening balance of retained earnings. Illustration uation An enti d the FEFO method of inventory, va since tbe ee perations in 2015. The entity decided to change to the weighted average method for determining inver" ory cost at the beginning of 2016. The following schedule sho' year-end inventory balances: FIFO Weighted average 750,000 2016 J3000,008 1,200,000 2016 1,500,000 1,000,000 FIFO inventory - Jd 1, 2016 ene entory - January 1, anid : Weighted average inventory - January |, nye Decrease in beginning inventory 277Adjustment of the decrease in beginning ventory Retained earnings 250,000 Inventory - January 1 250,009 The computation of the cost of goods sold for 2016 wou! then show beginning inventory at P750,000 and ending inventory at P1,200,000 to conform with the weighted Average method. The statement of changes in equity for the year ended December 31, 2016 would show the effect of the change of P250,000 net of tax as a deduction from the beginning balance of retained earnings. Limitation of retrospective application Restropective application of a change in accounting policy is not required if it is impracticable to determine the cumulative effect of the change. Applying a requirement of a standard is impracticable when the entity cannot apply it afte; T making every effort to do so. For a particular Prior period, it ig im: inge in an accounting policy when: The retrospective pplication requires significant estimate, and it ig impossible to distinguish objectively information about the estimate that: & Provides evide nee of circumstances that existed at that time, and b Would have been available at that time. 278Pe ae, prospective application spective application means that the new accounting policy is applied to events and transactions occurring after the date at which the policy is changed. When it is impracticable for an entity to apply a new accounting policy retrospectively because it cannot determine the cumulative effect of applying the policy to all prior periods, the entity shall apply the new policy prospectively from the earliest period practicable. In other words, if the amount of the adjustment on the opening balance of retained earnings cannot be reasonably determined, the change in. accounting policy shall be applied prospectively. No adjustments relating to prior periods are made either to the opening balance of retained earnings or other component of equity because existing balances are riot recalculated. Change in reporting entity A change in reporting entity is a change whereby entities change their nature and report their operations in such a way that the financial statements are in effect those of a different reporting entity. For example, this accounting change may result from changing the specific subsidiaries comprising the group of entities for which consolidated financial statements are Presented. A change in reporting entity js actually a change in accounting policy and therefore shall be treated retrospectively or retroactively to disclose what the statements world have looked like if the current entity had been existence in the prior year. In other words, the financial statements of all prior periods Presented shall be restated to show financial information ‘or the new reporting entity. 279i rd Absence of accounting standai se! h 10, provides that in the beens x i india that specifically applie s toa eae accounting ‘anagement shall use judgment in oolong or event, a7 cosountine policy that results in information that sere to the economic decision making needs of yse.t is re and faithfully represented. PAS 8, paragral Paragraphs 11 and 12 specify the following hierarchy of guidance which management may use when selecting accounting policies in such circumstances: a. Requirements of current standards dealing with similar matters. b. Definition, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Conceptual Framework for Financial Reporting. c. Most recent pronouncements of other standard-setting bodies that use a similar Conceptual Framework, other accounting literature and accepted industry practices. Prior period errors Prior period errors are o} nancial statements for failure to use or misuse missions and misstatements in the one or more periods arising from # of reliable information that: a Was available when financial statements for those periods Were authorized for issue, . Could reasonab) €N into acco of those financi Y be expected to have been obtained and {tn the preparation and presentati®! al Statements, Errors ma Mistakes ; ¥ occur as a ro, 8 i Of facts, fr " applying ace, ‘aud & Abo Sult of mathematical mistake i i as tion . unting policies, misinterpret@ OF Oversight, 280flow to treat prior period errors prior period errors ‘shall be corrected reti adjusting the opening balances of foisted ceningy” by affected assets and liabilities. nings ond If comparative statements are presented, i : 7 , the financia’ statements of the prior period shall be restated so as to valet the retroactive application of the prior period errors as a retrospective restatement. Retrospective restatement means correcting the recognition, measurement and disclosure of amounts of elements of financial statements as if a prior period error had never occurred. In other words, the net income, its components, retained earnings and other affected balances for the prior period presented shal! be adjusted accordingly. if the error occurred before the earliest prior period presented, the opening balances of assets, liabilities and equity for the earliest prior period presented shall be restated. When it is impracticable to determine the cumulative effect. at the beginning of the current period of an error on all prior periods, the entity shall restate the comparative information to correct the error prospectively from the earliest date practicable. 281CHAPTER 15 ERROR CORRECTION TECHNICAL KNOWLEDGE To know the definition of prior period errors. To understand the accounting treatment of prior Period errors. To be able to distinguish counterbalancing errors and noncounterbalancing errors. To be able to Prep in : are the necessary correcting entries for prio: T period errors. 496introduction Brrors can arise in respect of the recognition, measurement, presentation or disclosure of elements of financial statements. i t period errors disco i i potential curren! rors vered in that period corrected before the financial statements are autLGHad for jssue- However, material errors are sometimes not discovered until asubsequent period, and these prior period errors are corrected in the comparative information presented in the financial statements for that subsequent period. Prior period errors Prior period errors are omissions and misstatements in the entity's financial statements for one or more periods arising from a failure to use or misuse of reliable information that: a. Was available when financial statements for these periods were authorized for issue. b. Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Prior period errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretation of facts, and fraud. Treatment of prior period errors + material prior period errors An i ec r ee ee ais Es et of financial statements authorized retrospectively in the first s for issue after their discovery: A prior period error shall be corrected by retrospective restatement, meaning, if comparative atatemenss ie Presented, the prior year statements are restated to correct « the error. eriod error is an adjustment of the he correction of a prior f the earliest period beginning balance of retained earnings © Presented. 497Type of errors a. Statement of financial position errors b. Income statement errors Combined statement of financial position and income statement errors ¢ Statement of financial position errors Statement of financial position errors affect the statement of financial position or real accounts only, meaning, the improper classification of an asset, liability and capital account. In such a case, an entry is simply made to reclassify the account balances. Illustration a. Notes receivable is debited instead of accounts receivatile. b. Accounts payable is credited instead of notes payable. c. Preference share capital is credited instead of ordinary share capital. The pertinent reclassifying entries are: a. Accounts receivable XX Notes receivable xXx b. Accounts payable XX Notes payable xXx c. Preference share capital XX Ordinary share capital xXx 498jncome statement errors Income statement errors affect the income statement or nominal accounts only, meaning, the improper classification of revenue and expense accounts. These errors have no effect on the statement of financial position and on net income. Thus, @ reclassifying entry is necessary only if the error is giscovered in the same year it is committed. Otherwise, if the error is discovered in a subsequent year, no reclassifying entry is necessary because the nominal accounts for the current year are correctly stated. Illustration During 2016, the entity debited purchases instead of office supplies. If the error is discovered in 2016, the reclassifying entry is: Office supplies xx Purchases = If the error is discovered in 2017, no reclassifying entry is made. The office supplies account and purchases aceon’: ate already closed in 2016. 499bined statement of financial POSition : Goome statement errors hi f financial " affect both the statement o ncial positiy sete waieintht because they result in a misstatemen, income. M ay raid For example, if accrued salaries payable is overlooked, the effects are: a. Salaries expense is understated (income statement error) b. Liability is understated (statement of financial Position error). c. Net income is overstated (income statement error). d. Retained earnings account is overstated (statement of financial Position error). If depreciation is overstated, the effects are: a. Depreciation is overstated (income statement error). b. Property, plant and equipment are understated (statement financial position error). Combined statement of financial Position and income statement errors are classified as counterbalancing errors an cing errors, Counterbalancing errors Counterbalancing errors are errors which, if not detected, a* sutomatically Counterbal i . anced o ed in the ® r corrected In other wor, ; et 10 periods otra Srrors will be offset or corrected “ Wt Correct themselves aver two pet 500Effects of counterbalancing errors 4, The income statements for two successive periods are incorrect. 9. The statement of financial positio: ie uasorreck position at the end of the first 3, The statement of financial position at th red i correck at the end of the second Counterbalancing errors normally include the misstatement of the following: _ Inventory, including purchases and sales . Prepaid expense Accrued expense . Deferred income Accrued income op 9 Bo Overstatement of ending inventory On December 31, 2015, the physical count was overstated by ‘50,000. If the books for 2016 have not been closed, the entry on December 31, 2016 to correct the error is: Retained earnings 50,000 Inventory, January 1, 2016 50,000 The retained earnings account is debited because the net income ‘ of 2015 was overstated. The inventory account is credited because the ending inventory on December 31, 2015 was overstated. If the books for 2016 have been closed, no entry is necessary because the error in 2016 is counterbalanced in 2016. In other words, the ending inventory in 2015 becomes the beginning inventory in 2016. Thus, if the beginning inventory of 2016 is overstated, cost of goods sold would be overstated with a consequent understatement of net income. 601Vndorstatement ending inventory Op Deoember $1, 2018, the physical count wag Understat,, a by PSQ.0OD. Tf the books for 2018 have not been closed, the entry to the error on December 31, 2016 is: Correct Inventory, January 1, 2016 50,000 Retained earnings 50,009 The inventory account is debited and the retained earnj sccount is credited because the ending inventory of 2015 was understated with a consequent understatement of net income. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. Understatement of, purchases The same was recorded in 2016. The physical inventory on December 31, 2015 was correctly stated. If the books for 2016 have not been closed, the entry to correct the error on December 31, 2016 is: Retained earnings 50,000 Purchases 50,000 of 2015 wen verse eat is debited because net income The purchases secount is credited beca i s ‘use the purchase pertains % 2015 and the same is recorded in 2016, thus resulting ‘© it of 2016 Purchases, The Purchases account in 2016 ig Aceount in 2016 ig overstated Thue ee pv eile ce eeoverstatement of purchases and ending inventory i ded on D. qhe entity record December 31, 2015 P50,0 urchases in transit to which the entity had no isias ra game merchandise was included in the inventory of December 31, 2015. If the books for 2016 have not been closed, the entries to correct the error on December 31, 2016 are: ,, Purchases 50,000 Retained earnings 50,000 2. Retained earnings 50,000 Inventory, January 1, 2016 50,000 In the first entry, the purchases account is debited because the purchase pertains to 2016 and was erroneously recorded in 2015. The retained earnings account is credited because the net income of 2015 was understated by reason of overstated purchases. In the second entry, the retained earnings account is debited and the inventory account is credited because the ending inventory of 2015 was overstated resulting to overstatement of net income. Actually, the net effect of the error is zero on net income and retained earnings. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. ‘The purchases account in 2016 is overstated and the purchases account in 2016 is understated. Thus, they equalize each other. The inventory on December 31, 2015 was overstated resulting to overstatement of net income. The inventory on January 1, 2016 was also overstated and thus overstating cost of goods sold and understating net income, 503Understatement of sales The entity failed to record sales of P50,000 in 2015. The same was recorded in 2016. The physical inventory was correctly stated on December 31, 2015. If the books for 2016 have not been closed, the entry to corre ct the error on December 31, 2016 is: Sales 50,000 Retained earnings - 50,000 The sales account is debited because the same Pertains to 2015 and was recorded in 2016 thus overstating 2016 sales, The retained earnings account is credited because the 2015 net income was understated. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. The sales account of 2015 was understated and the sales account of 2016 was overstated. Thus, they equalize each other, 504Overstatement of sales Understatement of ending inventory The entity recorded on December 31, 2015 P50,000 of sales i: transit and to which the customer had no title. sam The cost of the merchandise was P30,000 and the same excluded from the December 31, 2015 inventory. es If the books for 2016 have not been closed, the entries to correct the error on December 31, 2016 are: 1. Retained earnings 50,000 Sales 50,000 2. Inventory, January 1, 2016 30,000 Retained earnings 30,000 In the first entry, the retained earnings account is debited because the 2015 net income was overstated. The sales account is credited because the sale pertains to 2016 and was erroneously recorded in 2015. In the second entry, the inventory account is debited and the retained earnings account is credited because the 2015 net income was understated by reason of understatement of 2015 ending inventory. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. The sales account in 2015 was overstated and the sales account in 2016 was understated and thus they counterbalance each other. The understated ending inventory on December 31, 2015 becomes the beginning inventory in 2016. ‘Thus, they equalize the effect on net income, 505Failure to record prepaid expense On January 1, 2015, the entity purchased an insurance for two years for P50,000. The payment was debited to an expense and no adjustment was made on December 31, 2015 for the prepaid insurance. If the books for 2016 have not been closed, the entry to correct the error on December 31, 2016 is: Insurance 25,000 Retained earnings 25,000 The insurance account is debited because the prepaid insurance on December 31, 2015 becomes an expense in 2016. The retained earnings account is credited because the 2015 net income was understated. If the books for 2016 have been closed, no entry is necessary because the error is counterbalanced. The net income of 2015 was understated by reason of overstatement of insurance expense while the net income of 2016 was overstated by reason of understatement of insurance expense. 506Pade Failure to record accrued expense on December 31, 2015, accrued rent expense of P50,000 was not recorded. If the books for 2016 have not been closed, the entry to correct the error on December 31, 2016 is: Retained earnings 50,000 Rent expense 50,000 The retained earnings account is debited because the net income of 2015 was overstated. The rent expense is credited because the accrual of 2015 necessarily was paid in 2016 and the same was debited to rent expense, thus overstating the rent expense of 2016. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. The net income of 2015 was overstated by reason of understatement of rent expense while the 2016 net income was understated by reason of overstatement of rent expense. 507Failure to record a deferred income January 1, 2016, the entity received rent for two years in a caesar of P50,000, The same was credited to rent income and no adjustment was made on December 31, 2015. Tf the books for 2016 have not been closed, the entry to correct the error on December 31, 2016 is: Retained earnings 25,000 Rent income 25,000 The retained earnings account is debited because the 2015 net income was overstated. The rent income is credited because the unearned income on December 31, 2015 becomes an income of 2016. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. The 2015 rent income was overstated while the 2016 rent income was understated. Thus, they counterbalance each other. Failure to record accrued income On December 31, 2015, accrued interest receivable of P50,000 was not recorded. If the books for 2016 have not been closed, the entry to correct the error on December 31, 2016 is: Interest income 50,000 Retained earnings 50,000 The interest income is debited because the interest accrual of 2015 necessarily was received in 2016 and the same was credited to interest income, thus overstating the 2016 interest income. The retained earnings account is credited because the 2015 income was understated. If the books for 2016 have been closed, no entry is necessary because the 2015 error is counterbalanced in 2016. The 2015 interest income was understated while the 2016 interest income was overstated. Thus, they equalize each other, 508Noncounterbalancing errors ncounterbalancing errors are errors which, if not. automatically counterbalan: ich, if not detected, areounting period. ced or corrected in the next Jn other words, if the net income of one year is understate overstated, the net income of subsequent year is no eeaek Effects of noncounterbalancing errors 1. The income statement of the period in which the error is committed is incorrect but the succeeding income statement js not affected. 2. The statement of financial position of the year of error and succeeding statement of financial position are incorrect until the error is corrected. The best example of a noncounterbalancing error is the misstatement of depreciation. Illustration On January 1, 2015, the entity purchased an equipment with useful life of 5 years for 500,000 but the same was debited to repair and. maintenance. If the books for 2016 have not been closed, the entries to correct the error on December 31, 2016 are: 1. Equipment 500,000 Retained earnings 500,000 2. Depreciation (500,000 15) 100,000 Retained earnings an 100,000 Accumulated depreciation 200,000 If the books for 2016 have been closed, the entries to correct the error on December 31, 2016 are: i 500,000 1, Equipment , Retained earnings 500,000 i i 200,000 2. Retained earning | , 7 ‘Accum ulated depreciation 200,000Illustration 1 An entity reported net income for 2014 P3,000,000, 2015 P4,000,000 and 2016 P3,500,000. 1. December 31, 2014 inventory overstated 120,000 2. December 31, 2016 inventory understated 210,009 3. December 31, 2014 accrued interest payable understated 40,000 4. December 31, 2016 accrued interest payable overstated 90,000 5. Depreciation for 2015 understated 180,000 6. Depreciation for 2016 overstated "30,000 2014 2015 2016 Net income per book 3,000,000 4,000,000 3,500,000 1. Overstatement of 2014 inventory ( 120,000) 120,000 2. Understatement of 2016 inventory 210,000 3. Understatement of 2014 accrued interest payable (40,000) 40,000 4. Overstatement of 2016 accrued interest payable / 90,000 5. Understatement of 2015 depreciation (180,000) 6. Overstatement of 2016 depreciation 30,000 Corrected net income 2,840,000 3,980,000 3,830,000 The books for 2016 have not yet been closed. Correcting entries on December 31, 2016 1. No adjustment. The overstatement of income in 2014 i+ counterbalanced by the understatement of income in 2015. Inventory — December 31, 2016 210,000 Profit and loss 210,000 No adjustment. The overstatement of income in 2014 is counterbalanced by the understatement of income in 2015. Accrued interest payable 90,000 Interest expense 90,000 Retained earnings 180,000 Accumulated depreciation 180,000 Accumulated depreciation 30,000 Depreciation 30,000 510filustration 2 n entity reported net in #9 900,000 and 2016 Pe, anne for 2014 P1,500,000, 2015 Fi 0,0 red following: 00. An audit disclosed the 1, Accounts receivable instead of n i was debited in 2016 seit 3. Purchabe 5 20,000 . Purchases account was debited in 2016 in office supplies 016 instead of na 5,000 3. The physical inventory on December 31, 2014 was overstated : 10,000 4, The Lica seca on December 31, 2015 was understated - 15,000 5, Advances to supplier were recorded as purchases but the merchandise was received in subsequent year: 2014 i 30,000 2015 40,000 6. Advances from customers recorded as sales but the goods were delivered in the following year: 2014 25,000 2015 50,000 7. Insurance premium for three years paid in 2014 was charged entirely to expense in 2014 15,000 8. Salaries accrued not recorded: 2014 30,000 2016 60,000 9. Rent for two years received in 2015 wasentirely credited to income ad 10. interest receivable: 0. Unreconded sexuee ’ st 10,000 m01e 25,000 ll. uilding had been charged to Improvements on pasoyp improvementahave allie of 5 years. oh 12, On January 1, 2015, an equipment costing P40,000 was sold for P20,000, ‘Atthe date of sale, the equipment had an accumulated depreciation ‘of P25,000. The cash received was recorded as other income in 2015. 511Worksheet for corrected net income 2014-2015 ang 1,600,000 2,000,000 2,800,099 Net income 1. Noeffect 2. Noeffect 3. 2014inventory overstated (10,000) 10,000 4, 2015inventory understated 15,000 ( 15,009) 5. Advances recorded as purchases 2014 30,000 — ( 30,000) 2015 40,000 ( 40,000) 6. Advancesrecorded assales 2014 ( 25,000) 25,000 2015 (50,000) 50,000 7. Insurance premium for 3 years debited to expense in 2014 10,000 ( 5,000) ( 5,000) 8. Salaries accrued unrecorded 2014 (30,000) 30,000 2016 (60,000) 9. Rentincome for 2 years recorded as income in 2015 ( 5,000) 5,000 10. Interest receivable unrecorded 2015 10,000 ( 10,000) 2016 25,000 11. Improvements debited to expense 100,000 Depreciation (100,000/6) ( 20,000) ( 20,000) 12. Overstatement of other income (15,000) Corrected net income 147 2,105,000 2,730,000 512correcting entries - December 31, 2016 The pooks for 2016 have not yet been closed, _ Notes receivable 1 hesounts receivable ete ‘This is only a reclassification entry. 9, Office supplies é 5,000 ‘This is also a reclassification entry. 3. Noadjustment. 20,000 5,000 The ending inventory of 2014 becomes the beginning inventory of 2015. Accordingly, the overstatement of income in 2014 is counterbalanced by the understatement of income in 2015. 4, Inventory—January 1, 2016 15,000 Retained earnings 15,000 The retained earnings account is credited because the income of 2015 was understated by reason of the understatement: of the 2015, inventory. 5. Purchases 40,000 Retained earnings 40,000 The retained earnings account is credited because the income of 2015 was understated by reason of the recording of advances in 2015 as purchases. The purchases account is debited because the advances of 2015 become purchases of 2016. The 2014 error of P30,000 requires no correction because the same is counterbalanced in 2015.5 a 50,000 Sales 50,000 ‘The retained earnings account is debited because the income of 2016 was overstated by reason of the recording of advances from customers in 2016 as sales. . The sales account is credited because the 2015 advances from customers become sales of 2016. The 2014 error of P25,000 requires no correction because the same is counterbalanced in 2015. 7. Insurance 5,000 Retained earnings 5,000 ‘The insurance accountis debited because this is the portion applicable to 2016. : The retained earnings account is credited because the income of 2014 was understated by P10,000 and the income of 2015 was overstated by P5,000, resulting to a net understatement of P5,000. 8. Salaries 60,000 : Accrued salaries payable 60,000 This is an ordinary adjustment of accrual on December 31, 2016. The 2014 error of P30,000 requires no correction because the same is counterbalanced in 2015. 9. Retained earnings 5,000 Rent inecne 5,000 The retained earnings account is debited because the income of 2015 was overstated. The rent income is credited because this is the portion applicable to 2016,10. i. 12. Interestincome Retained earnings ‘The interest income is debited because the -accrued interest receivable of 2015 is presumably collected in 2016 and credited to interest income. Thus, the interest incom: 2016 is overstated. ee ‘The retained earnings account is credited because the income of 2015 was understated py reason of nonrecording of accrued interest receivable. Accrued interest receivable Interest income This is an ordinary adjustment for accrual on December 31, 2016. Building Retained earnings The retained earnings account is credited because income of 2015 was understated by expensing the improvements on building. Retained earnings Depreciation Accumulated depreciation The amount debited to retained earnings pertains tothe depreciation of 2015. Ritained Sarai Accumulated depreciation Equipment. Sale price Carrying amount (40,000-25,000) Gain on sale of equipment in 2015 ; Cash received recorded as other income in 2015 Overstatement of income in 2015 515 19,000 25,000 100,000 20,000 20,000 15,000 25,000 10,000 25,000 100,000 40,000