Page |1

Chapter 7
Notes – Part 1

NAME: Date:
Professor: Section: Score:

ACCOUNTING POLICIES, CHANGES IN ESTIMATES & ERRORS

1. The primary distinction between a change in accounting estimate and the correction of an error is
the timing of availability of information; a change in estimate is based on new information not
previously available.

2. All changes in accounting policy are accounted for by retrospective application.

3. A company changes its depreciation method for machinery and equipment from sum-of-the-
years'-digits depreciation to the straight-line method. This is a change in accounting estimate.

4. A company reduces the lives of several patents from 17 to 10 years because of rapid technological
change. This is a change in accounting policy.

5. An analysis of the allowance for doubtful accounts showed the balance should be reduced by
₱27,500 due to recent changes in economic conditions. This is a change in accounting estimate.

6. A company changes from a non-acceptable to an acceptable accounting principle. This is a change

in accounting policy.

7. A company changes its depreciation method at the same time it recognizes a change in the
estimated useful life of the asset. This is a change in accounting policy.

8. The understatement of merchandise inventory is an example of an error that counterbalances after

two years.

9. Failure to record amortization is an example of a non-counter balancing error.

10. An understatement in ending inventory results to overstatement of profit during the period.

“Do not be anxious about anything, but in everything by prayer and supplication
with thanksgiving let your requests be made known to God. And the peace of God,
which surpasses all understanding, will guard your hearts and your minds in Christ
Jesus.” (Philippians 4:6-7)

- END -
 Page |2

ANSWERS
1. TRUE 6. FALSE
2. FALSE 7. FALSE
3. TRUE 8. TRUE
4. FALSE 9. TRUE
5. TRUE 10. FALSE
 Page |3

1. Conn Co. reported a retained earnings balance of ₱400,000 at December 31, 20X8. In August 20X9,
Conn determined that insurance premiums of ₱60,000 for the three-year period beginning January
1, 20X8, had been paid and fully expensed in 20X8. Conn has a 30% income tax rate. What amount
should Conn report as adjusted beginning retained earnings in its 20X9 statement of retained
earnings?
a. 420,000 b. 428,000 c. 440,000 d. 442,000

2. Foy Corp. failed to accrue warranty costs of ₱50,000 in its December 31, 20X4, financial statements.
In addition, a change from straight-line to accelerated depreciation made at the beginning of 20X5
resulted in a cumulative effect of ₱30,000 on Foy's retained earnings. Both the ₱50,000 and the
₱30,000 are net of related income taxes. What amount should Foy report as prior period
adjustment in 20X5?
a. 0 b. 30,000 c. 50,000 d. 80,000

3. Loeb Corp. frequently borrows from the bank in order to maintain sufficient operating cash. The
following loans were at a 12% interest rate, with interest payable at maturity. Loeb repaid each
loan on its scheduled maturity date.
Date of loan Amount Maturity date Term of loan
11/1/x1 ₱ 5,000 10/31/x2 1 Year
2/1/x2 15,000 7/31/x2 6 Months
5/1/x2 8,000 1/31/x3 9 Months

Loeb records interest expense when the loans are repaid. As a result, interest expense of ₱1,500 was
recorded in 20x2. If no correction is made, by what amount would 20x2 interest expense be
understated?
a. 540 b. 620 c. 640 d. 720

The next three items are based on the following:

Declaration, Inc., is a calendar year corporation. Its financial statements for the years 20x2 and 20x1
contained errors as follows:
20x2 20x1
Ending inventory ₱1,000 understated ₱3,000 overstated
Depreciation expense ₱800 understated ₱2,500 overstated

4. Assume that the proper correcting entries were made at December 31, 20x1. By how much will
20x2 income before income taxes be overstated or understated?
a. ₱200 understated. c. ₱2,700 understated.
b. ₱500 overstated. d. ₱3,200 understated.

5. Assume that no correcting entries were made at December 31, 20x1. Ignoring income taxes, by
how much will retained earnings at December 31, 20x2, be overstated or understated?
a. ₱200 understated. c. ₱2,700 understated.
b. ₱500 overstated. d. ₱3,200 understated.
 Page |4

6. Assume that no correcting entries were made at December 31, 20x1, or December 31, 20x2, and
that no additional errors occurred in 20x3. Ignoring income taxes, by how much will working
capital at December 31, 20x3, be overstated or understated?
a. ₱0. c. ₱1,000 understated.
b. ₱1,000 overstated. d. ₱1,700 understated.

7. Bren Co.'s beginning inventory at January 1, 20x3, was understated by ₱26,000, and its ending
inventory was overstated by ₱52,000. As a result, Bren's cost of goods sold for 20x3 was
a. Understated by ₱26,000. c. Understated by ₱78,000.
b. Overstated by ₱26,000. d. Overstated by ₱78,000.

The next three items are based on the following:

The bookkeeper of Latsch Company, which has an accounting year ending December 31, made the
following errors:
• A ₱1,000 collection from a customer was received on December 29, 20x0, but not recorded until
the date of its deposit in the bank, January 4, 20x1.
• A supplier's ₱1,600 invoice for inventory items received in December 20x0 was not recorded until
January 20x1. (Inventories at December 31, 20x0 and 20x1, were stated correctly, based on physical
count.)
• Depreciation for 20x0 was understated by ₱900. In September 20x0, a ₱200 invoice for office
supplies was charged to the Utilities Expense account. Office supplies are expensed as purchased.
• December 31, 20x0, sales on account of ₱3,000 were recorded in January 20x1.

Assume that no other errors have occurred and that no correcting entries have been made. Ignore
income taxes.

8. Profit for 20x0 was

a. Understated by ₱500. c. Overstated by ₱2,500.
b. Understated by ₱2,100. d. Neither understated nor overstated.

9. Assume the same facts as above. Working capital at December 31, 20x0, was
a. Understated by ₱3,000. c. Understated by ₱1,400.
b. Understated by ₱500. d. Neither understated or overstated.

10. Assume the same facts as above. Total assets at December 31, 20x0, were
a. Overstated by ₱2,500. c. Understated by ₱2,500.
b. Overstated by ₱2,100. d. None of the above.

“The name of the Lord is a strong tower; the righteous run to it and are safe.” (Proverbs
18:10)
- END -

SOLUTIONS:

1. B 400,000 + [(60,000 x 2/3) x 70%] = 428,000

 Page |5

2. C 50,000 – the correction for the prior period error. The change from straight-line to accelerated
depreciation is a change in accounting estimate that should be accounted for prospectively.

3. A
Solution:
The correct interest expense in 20x2 is computed as follows:
(5,000 x 12% x 10/12) 500
(15,000 x 12% x 6/12) 900
(8,000 x 12% x 8/12) 640
Correct interest expense - 20x2 2,040

Correct interest expense - 20x2 2,040

Interest expense recognized 1,500
Understatement 540
4. A
Solution:
Ending inventory - 20x2 1,000
Depreciation expense - 20x2 (800)
Understatement 200

The counter-balancing error in 20x1 does not affect the 20x2 profit because proper correcting entries were made on
December 31, 20x1.

5. C
Solution:
Effect on profit (over) under statement:
Errors on: 20x1 20x2
Ending inventory - 20x1 (3,000) 3,000
Ending inventory - 20x2 1,000
Depreciation expense - 20x1 2,500
Depreciation expense - 20x2 (800)
(500) 3,200

Effect on profit - 20x1 (500)

Effect on profit - 20x2 3,200
Effect on R/E, 20x2 - understatement 2,700

6. A The working capital on December 31, 20x3 is not affected because all of the counter -balancing errors
would have counter-balanced already as of this point. Errors on depreciation do not affect working
capital.

7. C
Solution:
Effect on COGS -
(over)/understatement
Understatement in beg. Inventory 26,000
Overstatement in end. Inventory 52,000
Net effect on COGS –
understatement 78,000
 Page |6

8. A
Solution:
Effect on profit (over)/understatement
Unrecorded collection -
Unrecorded purchases (1,600)
Understatement in depreciation (900)
Erroneous debit of office supplies
expense to utilities expense -
Unrecorded sales 3,000
Net effect on profit - understatement 500

9. C
Solution:
Effect on working capital (over)/understatement
Unrecorded collection -
Unrecorded purchases (1,600)
Understatement in depreciation -
Erroneous debit of office supplies
expense to utilities expense -
Unrecorded sales 3,000
Net effect on working capital - understatement 1,400

10. D
Solution:
Effect on total assets
(over)/understatement
Unrecorded collection -
Unrecorded purchases (Inventory is
properly stated) -
Understatement in depreciation (900)
Erroneous debit of office supplies
expense to utilities expense -
Unrecorded sales (Unrecorded
accounts receivable) 3,000
Net effect on total assets - understatement 2,100
 Page |7

Instruction: State whether the following events are adjusting or non-adjusting events after the
reporting period. All events took place after the end of the reporting period but before the financial
statements are authorized for issue

1. The entity guarantees the debt of another entity.

2. Settlement of a contingent event at an amount below the provision recognized as at the end of the
reporting period.

3. Major acquisition of a competitor company.

4. The actual sale of noncurrent assets held for sale provides information on the asset’s fair value less
costs to sell as at the end of the reporting period.

5. The resolution of a contingent event which provides evidence of the entity’s obligation to pay
bonus to a key management personnel for the services he has rendered during the reporting
period.

6. The conditions under PFRS 5 Non-current Assets Held for Sale and Discontinued Operations for
classifying a noncurrent asset or disposal group as held for sale are met.

7. Change in income tax rate.

8. The discovery that the accumulated patent amortization is understated.

9. A board resolution to change the depreciation method used for buildings.

10. Adoption and announcing of a formal plant to close a business segment.

“For the Lord gives wisdom; from his mouth come knowledge and understanding.”
(Proverbs 2:6)

- END -
 Page |8

ANSWERS
1. NON-ADJUSTING
2. ADJUSTING
3. NON-ADJUSTING
4. ADJUSTING
5. ADJUSTING
6. NON-ADJUSTING
7. NON-ADJUSTING
8. ADJUSTING
9. NON-ADJUSTING
10. NON-ADJUSTING
 Page |9

1. BOWDLERIZE TO EDIT Company’s current reporting period ends on December 31, 20x1. The
following transactions occurred after the end of reporting period:
a. On January 5, 20x2, BOWDLERIZE declared ₱4,000,000 dividends.
b. On January 15, 20x2, BOWDLERIZE issued 1,000 shares with par value per share of ₱200 for
₱1,200 per share.
c. On January 20, 20x2, BOWDLERIZE installed an oil rig. Current legislation requires that the
oil rig be uninstalled at the end of its useful life and the site where it was installed be restored.
BOWDLERIZE estimates the present value of the decommissioning and restoration cost at
₱2,000,000.
d. On February 1, 20x2, a building with a carrying amount as of December 31, 20x1 of ₱1,000,000
was totally razed by fire.
e. On February 10, 20x2, BOWDLERIZE received notice of a litigation in relation to an accident
that happened on December 31, 20x1. BOWDLERIZE estimates a probable loss of ₱400,000.
f. On March 5, 20x2, BOWDLERIZE purchased a subsidiary for ₱20,000,000 in a business
combination accounted for using the acquisition method. Goodwill of ₱5,000,000 was
recognized on the business combination.
The financial statements were authorized for issue on March 1, 20x2.

Requirement: Compute for the total amount of adjusting events.

2. PANTALOON TROUSER Company’s current reporting period ends on December 31, 20x1. The
following transactions occurred after the end of reporting period:
a. On January 20, 20x2, a pending litigation was resolved requiring a settlement amount of
₱200,000. The 20x1 year-end financial statements included a provision for loss on litigation of
₱240,000.
b. Inventories costing ₱2,000,000 were recognized at their net realizable value of ₱1,800,000 in the
20x1 year-end financial statements. During January 20x2, the inventories were sold for
₱1,760,000. Actual selling costs amounted to ₱60,000.
c. The year-end accounts receivable include a ₱200,000 receivable from XYZ, Inc. No allowance
for doubtful accounts was recognized on this receivable as of December 31, 20x1. On February
3, 20x2, XYZ filed for bankruptcy. It was estimated that the receivable will not be collected.
d. The fair value of financial assets measured at fair value through profit or loss significantly
declined to ₱160,000 on February 28, 20x2. The financial assets are recognized in the 20x1 year-
end financial statements at ₱600,000 which is their fair value as of December 31, 20x1.
e. On March 5, 20x2, a case was resolved requiring a settlement amount of ₱400,000. The 20x1
year-end financial statements included a provision for loss on litigation of ₱300,000.
PANTALOON Company’s profit for the year ended December 31, 20x1 before consideration of the
above transactions is ₱4,400,000. The financial statements were authorized for issue on March 1, 20x2.
Requirement: Compute for the adjusted profit for the year. Provide journal entries.

“I press on toward the goal to win the prize for which God has called me heavenward in Christ
Jesus.” (Philippians 3:14)
- END –

SOLUTION

1. Solution:
 P a g e | 10

Estimated liability on pending litigation 400,000

Total adjusting events 400,000

Adjusting events are those that provide evidence of conditions that existed at the end of the reporting
period. Those that are indicative of conditions that arose after the reporting period are non-adjusting
events.
Thus, the declaration of dividends, issuance of shares, and impairment of the building after
the reporting period are non-adjusting events. There is no present obligation for decommissioning and
restoration costs as of the end of reporting period because the oil rig was installed after the reporting
period.
The business combination is neither recognized nor disclosed in the December 31, 20x1
financial statements because the business combination is not an event after the reporting period, i.e., it
occurred after the financial statements were authorized for issue.

2. Solution:
Unadjusted profit, December 31, 20x1 4,400,000
Reduction in provision for loss on pending litigation
(240K – 200K) 40,000
Reduction in NRV of inventories [1.8M - (1.76M – 60K)] (100,000)
Impairment loss on receivables (200,000)
Adjusted profit, December 31, 20x1 4,140,000

Pertinent adjusting entries are:

Dec. 31, 20x1 Estimated liability on pending litigation 40,000
Probable loss on litigation 40,000
Dec. 31, 20x1 Cost of goods sold 100,000
Inventory 100,000
Dec. 31, 20x1 Impairment loss on receivables 200,000
Accounts receivable 200,000