AUD2 – Auditing and Assurance: Concepts and Applications 1

ACCOUNTING CHANGES AND CORRECTION OF ERRORS

PROBLEM 1

Hachi, Corp. acquired the following assets in January 2016:

Equipment, estimated useful life, 5 years, no salvage value P780,000
Building, estimated useful life, 40 years, salvage value, P600,000 6,600,000

The equipment has been depreciated using the double-declining balance method for the first 2 years for financial reporting
purposes. In 2018, the company decided to change the method of computing depreciation to the straight-line method for the
equipment, but no change was made in the estimated useful life or salvage value. It was also decided to change the total
estimated useful life of the building from 40 years to 35 years, with no change in the estimated salvage value. The building is
depreciated on the straight-line method.

Required: 1. Prepare the journal entry related to the equipment in 2018.

2. Prepare the journal entry related to the building in 2018.

PROBLEM 2

Taro, Inc. purchased equipment on January 1, 2017 for P750,000. At that time, it was estimated that the equipment would have
a 5-year life and no salvage value. On December 31, 2018, the firm’s accountant found that the entry for depreciation expense
had been omitted in 2017. In addition, management has informed the accountant that the company plans to switch to the sum-
of-the-years’ digits method for depreciating equipment, starting with the year 2018. At present, the company uses the straight
line method of depreciation.

Required: Prepare the journal entries that should be made on December 31, 2018.

PROBLEM 3
Required:
1. Indicate the effects (overstated/understated/no effect) on the net income of 2020 and 2021.
2. Prepare the adjusting entries assuming these errors were corrected in 2020.
3. Prepare the adjusting entries assuming these errors were corrected in 2021 .

Effect on Effect on 2021 Effect on Effect on

Omissions in 2020 of:
2020 Net Income 12.31.2020 12.31.2021
Net Income Equity Equity
1. Depreciation expense

2. Accrued salaries

3. Interest receivable

4. Prepaid rent

5. Unearned interest

6. An item of ending inventory

7. Purchases

PROBLEM 4
Show how the following errors will affect the net income in 2020 and 2021 and the shareholders’ equity balance at December 31,
2020 and 2021. Prepare also the adjusting entries assuming the errors were discovered in 2021.
2020 2021
Net Income Equity at end Net Equity at
of year Income end of year
1. Failed to accrue 2020 wages of P30,000.

2. Failed to accrue 2020 interest income of P2,000.

3. Failed to count office supplies on hand of P5,000 at 12/31/2020.
Cash payments have already been charged to office supplies
expense in 2020.
4. At the end of 2020, received P12,000 cash from a customer for
services the company is to perform evenly over a year. Full amount
was recorded as revenue in 2020 and no adjustment was taken up
at year-end.
5. Beginning inventory in 2020 was overstated by P4,000.

6. Ending inventory at December 31, 2020 was overstated by

P75,000.
7. Purchase of goods for P20,000 made late in 2020 was erroneously
recorded in 2021, but correctly counted in 2020 final inventory.
8. Purchase of goods for P100,000 made late in 2020 was recorded in
2021. These goods were also erroneously excluded from the 2020
final inventory.
9. 2020 depreciation expense was understated by P10,000. 2021
depreciation is correct.
10. A capital expenditure on January 1, 2020 for equipment costing
P90,000 with 3-year estimated useful life was charged to repairs
expense.
11. Failed to count office supplies on hand of 20,000 at 12/31/2019.
Cash payments have already been charged to office supplies
expense in 2019.
12. Payment for a one-year insurance policy was made on 01/01/2020.
However, the prepayment amortization was erroneously calculated
as a three-year insurance policy. Amortization was recorded in
2020 and 2021.

PROBLEM 5

1. On December 31, 2017, the Company failed to accrue wages of P15,000. This were paid to employees in the first week of
January 2018.

2. In January 1, 2017, the Company purchased a one-year insurance costing P100,000. It debited Insurance Expense and
credited Cash. The Company made no adjusting entry at the end of 2017.

3. On December 31, 2017, the Company received P50,000 as prepayment for renting office space for the following year. At
the time of receipt of the rent, the Company recorded a debit to Cash and a credit to Rent Revenue. It made no adjusting
entry as of December 31, 2017.

4. On December 31, 2017, the Company accrued as interest revenue P8,000 that applied to 2018. On that date, the Company
recorded a debit to Interest Receivable and a credit to Interest Revenue.

5. The Company recorded a purchase of merchandise for P9,000 in 2017 and applied it to 2018. The physical inventory for
2017 was correctly stated. The company uses the periodic inventory method.

6. In January 1, 2017, the Company purchased a two-year insurance costing P100,000. It debited Insurance Expense and
credited Cash. The Company made no adjusting entry at the end of 2017.

7. On January 1, 2017, the company purchased a machine for P10,000 that had an estimated useful life of five years. The
accountant incorrectly expensed this machine in 2017.

Required: Prepare all necessary adjusting entries under each of the following assumptions:

a. Assume that the errors were discovered when the 2017 books of accounts were still open.

b. Assume that the errors were discovered during the preparation of 2018 financial statements (when the 2017 books have
already been closed).

c. Assume that the errors were discovered during the preparation of 2019 financial statements (when the 2018 and 2017
books have already been closed).
PROBLEM 6
Since its organization in 2016, Delta Company failed to properly recognize accruals and prepayments. Selected accounts
revealed the following information:
2016 2017 2018
Accruals and deferrals not recognized at end of year:
Accrued expenses P32,000 P25,000 P12,500
Prepaid expenses 3,000 4,000 2,350
Accrued revenue 21,000 17,000 7,800
Unearned revenue 11,000 12,000 2,000

Depreciation not recognized each year: 5,000 5,000 5,000

Net income (loss) reported: (P50,000) P200,000 P300,000

Compute for the corrected net income for each year.

PROBLEM 7
A client’s financial statements for 2017 and 2018 included the following errors:
Year Ending Inventory Depreciation Expense
2017 P62,000 understated P60,000 understated
2018 P12,000 understated P45,000 understated

Net income was P150,000 in 2017 and P170,0000 in 2018 before any adjustments to correct these errors.

1. Prepare all necessary journal entries to correct all affected accounts during the preparation of the 2018 and 2017
comparative financial statements.
2. Compute for the correct net income in 2017 and 2018.
3. For how much should retained earnings be retrospectively adjusted at January 1, 2018?

PROBLEM 8

A client started operations on January 1, 2017. Financial statements for the years ended December 31, 2017 and 2018
contained the following errors:
2017 2018
Inventory, 12/31 P25,000 understated P15,000 overstated
Prepaid insurance, 12/31 2,750 overstated
Insurance expense 2,750 understated 2,750 overstated
Depreciation expense 4,500 understated

The client reported net income of P100,000 and 200,000 for 2017 and 2018, respectively, before any corrections to net income.

Compute for the correct net income for 2017 and 2018.

PROBLEM 9

A Company reported net income the 2017 and 2018 at P458,000 and P369,000, respectively. Your audit of the company’s
accounts disclosed the need for adjustments as follows:
2017 2018
Overstatement of ending inventories P35,400 P19,500
Overstatement of beginning inventory 35,400
Omission of depreciation on newly acquired equipment 22,500 22,200
Understatement of prepaid insurance 37,000 31,000
A purchase of merchandise was not recorded until the
following year, but included in year-end inventory 20,000

How much is the adjusted net income for 2017 and 2018?