ANALYSIS OF DEFERRALS AND ACCRUALS

ERROR- Failure to record Effect on Income Effect on Balance Sheet Journal Entry to Correct the
Statement of the Current accounts at the end of the Errors
Period current period *assume error is detected
before closing the books

ACCRUED REVENUE Interest Income U Interest Receivable U Interest Receivable

Ex. Accrued Interest Income Net Income U Retained Earnings U Interest Income
UNEARNED REVENUE
Ex. Rent Received in Advance Rent Revenue O Unearned Rent U RENT REVENUE
(credit to Revenue when Net Income O Revenue UNEARNED RR
cash is received) Retained Earnings O
Rent Received in Advance (
credit to Unearned Rent Rent Revenue U Unearned Rent O UNEARNED RR
Revenue when cash is Net Income U Revenue RENT REVENUE
received) Retained Earnings U
ACCRUED EXPENSES Salaries Expense U Salaries Payable U SALARIES EXP
Ex. Salaries Payable Net Income O Retained Earnings O SALARIES PAYABLE
PREPAID EXPENSES
Ex. Prepaid Insurance Insurance O Prepaid Insurance U PREPAID INSURANCE
(debited to Insurance Expense Retained Earnings U INSURANCE EXP
Expense when cash is paid) Net Income U

Prepaid Insurance (debited Insurance U Prepaid Insurance O INSURANCE EXP

to Prepaid Insurance when Expense Retained Earnings O PREPAID INSURANCE
cash is paid) Net Income O
ILLUSTRATION 1: COMBINED AND COUNTERBALANCING ERRORS

Self-sacrifice Company reported net income for a two-year period as follows:

2020 – 120,000 2021 – 180,000

In an audit of the financial statement for the year ended December 31, 2020. The following errors are discovered:

1. The company paid one-year insurance premium of P18,000 effective May 1, 2020. The entire amount was
debited to expense account and no adjustment was made at the end of 2020.
2. The company leased a portion of its building for P24,000. The term of the lease is one year ending June 1, 2021.
Collection of rent was credited to rent revenue account. At the end of 2020, no entry was made to take up the
unearned portion of the amount collected.
3. Accrued salaries expense of P12,000 was not recorded at the end of 2020.
4. Accrued interest receivable of P15,000 was not recorded at the end of 2020.

Required:

1. Compute for the adjusted net income in 2020 and 2021 and Retained earnings as of the years ended December
31, 2020 and 2021.
2. Give the effect of the error in the 2020 working capital.
3. Prepare adjusting entries assuming errors were discovered in (a) 2020, (b) 2021, and 2022.

SOLUTION:

Net INCOME RETAINED EARNINGS

2020 2021 2020 2021
Unadjusted balance 120,000 180,000 120,000 300,000
1. Insurance expense, 6,000 (6,000) 6,000
over, NI under
2. Rev. over, NI over (10,000) 10,000 (10,000)
3. Salaries expense (12,000) 12,000 (12,000)
under, NI over
4. Interest income 15,000 (15,000) 15,000
under, NI under
Adjusted Balance 119,000 181,000 119,000 300,000

EFFECT ON THE WORKING CAPITAL

OVER OR (UNDER) 2020

1. Insurance expense, over; Prepaid insurance under, WC under (6,000)
2. Revenue over; Unearned revenue under, WC over 10,000
3. Salaries expense under, Salaries payable under, WC over 12,000
4. Int. income under, Rent receivable under, WC under (15,000)
Effect on the Working Capital – overstated by 1,000
REQUIREMENT 2:

Adjusting Entries if error is discovered in:

2020:
Prepaid Insurance (18000/12 x 4) 6000
Insurance Expense 6000

Rent Revenue (24000/12 x 5) 10000

Unearned Rent Revenue 10000

Salaries Expense 12000

Salaries Payable 12000

Interest Receivable 15000

Interest Income 15000

2021:
Insurance Expense (18,000/12 x 4) 6,000
Retained Earnings 6000
Retained Earnings 10,000
Rent Revenue ( 24000 /12 x 5) 10,000
Retained Earnings 12,000
Salaries Expense 12,000
Interest Income 15,000
Retained Earnings 15,000

2022: NO ADJUSTING ENTRIES

ILLUSTRATION 2: COMBINED AND COUNTERBALANCING ERRORS

Self-Sacrifice Company reported net income for a two-year period as follows:

2020 – 120,000 2021 – 180,000

In an audit of the statement for the year ended December 31, 2020, the following errors are discovered:

1. Advances to supplier in 2020 were recorded as purchases but the merchandise was received in the following
year, P20,000.
2. Advances from customers in 2020 recorded as sales in 2020 but the goods were delivered in the following
year, P50,000.
3. On December 31, 2020, the ending inventory was overstated by P25,000.

REQUIRED:

1. Compute for the adjusted net income in 2020 and 2021 and Retained Earnings as of the years ended December
31, 2020 and 2021.
2. Give the effect of the error in the 2020 working capital.
3. Prepare adjusting entries assuming errors were discovered in 2020, 2021 and 2022.
SOLUTION:

Net INCOME RETAINED EARNINGS

2020 2021 2020 2021
Unadjusted balance 120,000 180,000 120,000 300,000
1. Purchases over, NI 20,000 (20,000) 20,000
under
2. Sales over, NI over (50,000) 50,000 (50,000)
3. Ending Inventory (25,000) 25,000 (25,000)
over, NI over
Adjusted Balance 65,000 235,000 65,000 300,000

EFFECT ON THE WORKING CAPITAL

OVER OR (UNDER) 2020

1. Purchases over; Advances to supplier under, WC under (20,000)
2. Sales over; Advances from customer under, WC over 50,000
3. Ending inventory over, WC over 25,000
Effect on the Working Capital – overstated by 55,000

REQUIREMENT 2:

Adjusting Entries if error is discovered in:

2020:
Advances to Supplier 6000
Purchases 6000

Sales 10000
Advances from customer 10000

Cost of Sales 12000

Merchandise inventory, end 12000

2021:
Purchases 20000
Retained Earnings 20000

Retained Earnings 50,000

Sales 50,000
Retained Earnings 25,000
Mdse Inventory, beg. 25,000

2022: NO ADJUSTING ENTRIES

EXERCISES:

Shannon Company began operations on January 1, 2020. The financial statements contained the following errors:

2020 2021
Ending inventory 160,000 understated 150,000 overstated
Depreciation expense 60,000 understated
Insurance expense 100,000 overstated 100,000 understated
Prepaid insurance 100,000 understated

On December 31, 2021, fully depreciated machinery was sold for P110,000 cash but the sale was not recorded until
2022. No corrections have been made for any of the errors.

Ignoring income tax, what amount should be reported as net effect of the errors on:

1. Net Income for 2020

2. Net Income for 2021
3. Retained earnings on December 31, 2021
4. Working capital on December 31, 2021
ILLUSTRATION: COMBINED AND NONCOUNTER-BALANCING ERRORS

Self-sacrifice Company reported net income for a two-year period as follows:

2020 – 6,000,000 2021- 8,000,000

In an audit of the statement for the year ended December 31, 2020, the following errors are discovered:

1. The company paid one-year insurance premium of P240,000 effective April 1, 2020. The entire amount was
debited to asset account and no adjustment was made at the end of 2020.
2. The company leased a portion of its building for P480,000. The term of the lease is one year ending April 30,
2021. Collection of rent was credited to unearned rent revenue account. At the end of 2020, no entry was made
to take up the earned portion of the amount collected.
3. Depreciation expense in 2020 was understated by P12,000
4. Depreciation expense in 2021 was overstated by P14,000.
5. Bad debts expense of P11,000 was not recorded in 2020.

Required:

1. Adjusted Net Income in 2020 and 2021 and Adjusted Retained Earnings
2. Give the effect of the error in 2020 working capital.
3. Prepare AJEs.

SOLUTION:

NET INCOME RETAINED EARNINGS

Unadjusted Balances 6,000,000 8,000,000 6,000,000 14,000,000
1. Ins. Exp under, NI under (180,000) (60,000) (180,000) (240,000)
2. Rev. Under, NI under 320,000 160,000 320,000 480,000
3. Depr under, NI over (12,000) (12,000) (12,000)
4. Depr over, NI under 14,000 14,000
5. Bad debts under, NI (11,000) (11,000) (11,000)
over
Adjusted Balance 6,117,000 8,114,000 6,117,000 14,231,000
EXERCISES: ERROR CORRECTION
For three years Chona’s Merchandise failed to recognize accruals, prepayments and other transactions to its
accounts. Reported net income and a listing of the errors appear below:

2020 2021 2022

Reported Net Income/(Loss) 1,200,000 400,000 (100,000)
a. Failed to record accrued 20,000 25,000 48,000
expenses
b. Failed to record accrued 13,000 18,000 0
salaries
c. Understated depreciation 12,000 15,000 15,000
expenses
d. Overstated ending 36,000 28,000 0
inventories
e. Failed to record purchase on 0 0 40,000
account; merchandise
properly included in ending
inventory
f. Failed to recognize unused 3,000 0 4,000
supplies at the end of the
accounting period
g. Failed to recognize gain on 60,000 0 0
sale of land; Land credited
for amount of proceeds
h. Failed to recognize unearned 0 5,000 9,000
revenue at end of accounting
period.

Required: Prepare a schedule to correct the reported net income for each year. Prepare the correcting entry.

NET INCOME CORRECTING ENTRY AS OF

12/31/22
2020 2021 2022
Reported Net
Income/(Loss)
P5 000’s omitted Correcting Entry

NET INCOME Required as of 12.31.22

2020 2021 2022 Account Titles Dr. Cr.

Reported net income(loss) 1,200 400 (100)

a. Failed to record Retained Earnings 25

[Link]. –
2020 (20) 20 Expenses 23

2021 (25) 25 Accrued Ex. 48

2022 (48)

b. Failed to record Retained Earnings 18

accrued sal. –
2020 (13) 13 Salaries Ex 18
2021 (18) 18

c. Understated [Link]. (12) Depreciation Ex. 15

(15) Retained Earnings 27

(15) Acc. Depr. 42

d. Overstated EI – 2020 (36) 36 Retained Earnings 28

2021
(28) 28 Cost of Sales 28

e. Failed to record….. (40) Purchases 40

AP 40

f. Failed to recognize
unused supplies, end
of 2020 Unused Supplies 4
2022 3 (3) Supplies Ex. 4

g. Failed to recognize Land 60

gain …….
60 RE 60

h. Failed to recognize RE 5
unearned rev. – 2021
2022 (5) 5 Rent Revenue 4

(9) Unearned Rev. 9

Corrected net inc. (loss) 1,182 375 (132)