FAR EASTERN UNIVERSITY – MANILA

INSTITUTE OF ACCOUNTS, BUSINESS, AND FINANCE

NICANOR REYES SR. ST., SAMPALOC, MANILA
APPLIED AUDITING

CORRECTION OF ERRORS.

Error – an unintentional misstatement in financial statements

➢ Current period errors
- discovered in the same period the error was committed
- should be corrected before the FS are authorized for issue
- becomes a prior period error in the subsequent period if not corrected in the
current period
➢ Prior period errors
- discovered in a subsequent period
- should be corrected retrospectively
(retrospective restatement of affected comparative statements presented)

Effects of Errors ( A = L + E )
Net Retained Working Noncurrent Noncurrent
Income Earnings Capital Assets Liabilities
Sales (Income) Direct Direct
Cost of Sales (Expenses) Inverse Inverse
Net Purchases Inverse Inverse
Ending Inventories Direct Direct
Current Assets Direct Direct Direct
Current Liabilities Inverse Inverse Inverse
Noncurrent Assets Direct Direct Direct
Noncurrent Liabilities Inverse Inverse Direct

Types of Errors
1. Statement of financial position errors
- should be reclassified when discovered
2. Income statement errors
- should be reclassified in the same year the error is committed
3. Combined statement of financial position and income statement errors
a. Counterbalancing errors
i. Omission (UNDERSTATEMENT) of:
1. Accrued expense
2. Accrued income
3. Deferred expense (prepaid expense under expense method)
4. Deferred income (unearned income under revenue method)
ii. Ending inventory errors (overstatement or understatement)
iii. Sales/Purchases omitted in Y1 and recorded in Y2 (and vice versa)
b. Non-counterbalancing errors
i. Depreciation expense errors
ii. Gain or loss errors
iii. Others

❖ Steps in solving problems related to correction of errors

1. Draw a table with needed columns (NI/RE/WC/NCA/NCL and years under each).
2. Identify the type of each error (SFP, IS, or combined OR not an error).
3. SFP or IS error or not an error – NO EFFECT in NI; if the error is a combined SFP and IS
error, identify if the error is counterbalancing or non-counterbalancing.
4. NI column: Determine the effects of the error in the NET INCOME of the appropriate
year/s and write the correction on the NI column. [US, add (+); OS, deduct (-)]
5. RE column: For the RE column of a specific year, add the amounts written on the NI
column of the same year and all the prior years.
(For example: RE 2019 = NI 2019 + NI 2018, and so on if applicable)
6. WC column: If error is related to WC, copy the amounts written on the RE column.
a. If CA column: Copy the amounts written on the RE column.
b. If CL column: Reverse the operation of the amounts written on the RE column.
7. NCA column: If error is related to NCA, copy the amounts written on the RE column.
8. NCL column: …NCL, reverse the operation of the amounts written on the RE column.
9. Compute the total corrections and determine if US or OS. [(+) = US; (-) = OS]
10. Add the unadjusted balances to the totals to get the corrected balances.
11. Correcting entries can also be derived from the table.

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 ILLUSTRATIVE PROBLEMS

PROBLEM 1
You discovered the following errors in connection with your examination of the financial
statements of AAA Company:
1. Notes receivable of P56,000 in 2018 was erroneously debited to accounts receivable.
2. Accounts payable of P28,000 in 2018 was erroneously credited to notes payable.
3. Interest income of P50,000 in 2018 was erroneously credited to rent income.
4. Rent expense of P25,000 in 2018 was erroneously debited to interest expense.

The following data were extracted from the financial statements of AAA Company:

2018 2019
Net income P400,000 P320,000
Working capital, end P360,000 P520,000
Retained earnings, end P400,000 P720,000

Questions:

Based on the above data, determine the following:

1. Net income – 2018
2. Retained earnings, end – 2018
3. Working capital, end – 2018
4. Net income – 2019
5. Retained earnings, end – 2019
6. Working capital, end – 2019

PROBLEM 2
You discovered the following errors in connection with your examination of the financial
statements of BBB Company:
1. The company failed to accrue salaries expense of P150,000 incurred in 2018. The
expense was recorded when the salaries were paid in early 2019.
2. The company failed to accrue interest income of P200,000 earned in 2018. The income
was recorded when the interest was received in 2019.
3. The company paid a two-year insurance premium of P360,000 effective January 1, 2018.
The entire amount was debited to an expense account and no adjustment was made at
the end of 2018.
4. The company leased a portion of its building for P300,000 per year. The term of the lease
is two years ending December 30, 2019. Collection of rent was credited to rent revenue
account. At the end of 2018, no entry was made to take up the unearned portion of the
amount collected.
5. Sale of merchandise on account on December 29, 2018 amounting to P800,000 was not
recorded until it was collected in January 2019. The merchandise was properly
excluded in the ending inventory in 2018.
6. Purchase of merchandise on account on December 29, 2018 amounting to P600,000
was not recorded until it was paid in January 2019. The merchandise was properly
included in the ending inventory in 2018.
7. On December 31, 2018, the ending inventory was overstated by P200,000.

The following data were extracted from the financial statements of AAA Company:

2018 2019
Net income P2,000,000 P1,600,000
Working capital, end P1,800,000 P2,600,000
Retained earnings, end P2,000,000 P3,600,000

Questions:

Based on the above data, determine the following:

1. Net income – 2018
2. Retained earnings, end – 2018
3. Working capital, end – 2018
4. Net income – 2019
5. Retained earnings, end – 2019
6. Working capital, end – 2019

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PROBLEM 3
You discovered the following errors in connection with your examination of the financial
statements of CCC Company:
1. The company paid a two-year insurance premium of P360,000 effective January 1,
2018. The entire amount was debited to an asset account and no adjustment was
made at the end of 2018.
2. The company leased a portion of its building for P300,000 per year. The term of the
lease is two years ending December 30, 2019. Collection of rent was credited to
unearned rent revenue account. At the end of 2018, no entry was made to take up the
earned portion of the amount collected.
3. Depreciation expense on a machinery in 2018 was overstated by P120,000.
4. Improvements on building amounting to P2,000,000 had been charged to expense on
January 1, 2018. Improvements have a life of 4 years.
5. Repairs expense on the building amounting to P20,000 had been charged to the building
account on January 1, 2018. Depreciation expense was recorded in 2018 and 2019 based
on the 5 years remaining useful life of the building.
6. On January 1, 2018, an equipment costing P600,000 was sold for P200,000. At the date of
sale, the equipment had an accumulated depreciation of P480,000. The cash received
was recorded as other income in 2018.

The following data were extracted from the financial statements of AAA Company:

2018 2019
Net income P2,000,000 P1,600,000
Working capital, end P1,800,000 P2,600,000
Noncurrent assets, end P5,000,000 P5,000,000
Retained earnings, end P2,000,000 P3,600,000

Questions:

Based on the above data, determine the following:

1. Net income – 2018
2. Retained earnings, end – 2018
3. Working capital, end – 2018
4. Noncurrent assets, end – 2018
5. Net income – 2019
6. Retained earnings, end – 2019
7. Working capital, end – 2019
8. Noncurrent assets, end – 2019

PROBLEM 4
You have been asked by a client to audit the financial statements of DDD Company for the
first time. In examining the books, you found that certain adjustments had been overlooked at
the end of 2018 and 2019. You also discovered that other items had been improperly
recorded. These omissions and other errors for each year are presented below:

2018 2019
Ending inventory P300,000 understated P500,000 overstated
Depreciation expense P550,000 overstated P350,000 overstated
Prepaid expenses P225,000 understated P375,000 understated
Unearned income P250,000 understated -
Accrued expenses - P150,000 understated
Accrued income P60,000 understated -
Advances to suppliers were
recorded as purchases but the P1,000,000 P2,000,000
merchandise was received in the
following year.
Advances from customers were
recorded as sales but the goods P1,000,000 P3,500,000
were delivered in the following year.

Additionally, on January 1, 2018, a fully-depreciated equipment costing P2,000,000 was

sold for P300,000. The transaction was not recorded.
Doubtful accounts expense is determined each year at 1% of credit sales. Actual
collection experience of recent years shows that 0.75% is a better indication of
uncollectible accounts. Management effects the change in 2019. Credit sales for 2019
amounted to P40,000,000; in 2018, P37,000,000.

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Questions:

Based on the above data, compute the net effect of the errors on the company’s:
1. Net income in 2018
2. Retained earnings at December 31, 2018
3. Current assets at December 31, 2018
4. Current liabilities at December 31, 2018
5. Working capital at December 31, 2018
6. Noncurrent assets at December 31, 2018
7. Net income in 2019
8. Retained earnings at December 31, 2019
9. Current assets at December 31, 2019
10. Current liabilities at December 31, 2019
11. Working capital at December 31, 2019
12. Noncurrent assets at December 31, 2019

PROBLEM 5
EEE Company engaged you in 2019 to examine its books and records and to make
whatever adjustments are necessary. Your examination disclosed the following:

a. Prior to any adjustments, the retained earnings account is reproduced below:

RETAINED EARNINGS

Date Particulars Debit Credit Balance

2017
Jan. 1 Balance P 5,800,000
Dec. 31 Profit for the year P 3,100,000 8,900,000

2018
Jan. 1 Dividends paid P 1,000,000 7,900,000
Dec. 31 Loss for the year 2,050,000 5,850,000

2019
Jan. 1 Dividends paid 1,000,000 4,850,000
Dec. 31 Loss for the year 1,655,000 3,195,000

b. The company failed to properly recognize accruals and prepayments. Selected

accounts revealed the following information:

2016 2017 2018 2019

Prepaid expenses P85,000 P62,000 P74,000 P95,000
Accrued expenses P54,000 P73,000 P87,000 P90,000
Unearned income P69,000 P78,000 P89,000 P96,000
Accrued income P47,000 P56,000 P62,000 P78,000

c. Dividends had been declared on December 31 in 2017 and 2018 but had not been
entered in the books until paid.
d. The company purchased a machine worth P2,700,000 on April 30, 2016. The company
charged the purchase to expense. The machine has an estimated life of 3 years. The
company uses the straight-line method and residual values are deemed immaterial.
e. The physical inventory of merchandise had been understated by P640,000 and by
P445,000 at the end of 2017 and 2019, respectively.
Based on the audit findings, compute the adjusted balances of (disregard tax implications):
1. Retained earnings at December 31, 2016
2. Profit for 2017
3. Retained earnings at December 31, 2017
4. Loss for 2018
5. Retained earnings at December 31, 2018
6. Loss for 2019
7. Retained earnings at December 31, 2019
8. Current assets at December 31, 2016
9. Current liabilities at December 31, 2017
10. Working capital at December 31, 2018
11. Noncurrent assets at December 31, 2016
12. Noncurrent assets at December 31, 2019

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