11/24/2020 ACCOUNTING

CHANGES AND
ERROR CORRECTION
MODULE 01

KARL GUERRA
DLSAU

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AUDITING PROBLEM MODULE 01

ACCOUNTING CHANGES AND ERROR CORRECTION

MODULE O1

LEARNING OBJECTIVES:

After studying this chapter, you should be able to:

1. Understand types of errors.
2. Understand the effects of accounting changes.
3. Compute for the correct net income, working capital, and accumulated profits after
adjustments.
4. Record the adjusting entries.
5. Compute for the effects of accounting changes.

THEORETICAL
SECTION 1

PRIOR PERIOD ERRORS

The entity shall correct material prior period errors retrospective in the first set of financial
statements authorized for issue after their discovery by restating the net income and
accumulated profits of prior period.

ERRORS:

COUNTERBALANCING
• The error will be corrected in the statement of financial position in the succeeding
period. But the statement of financial performance is inaccurate for the two periods.
• Examples include:
o Understated or Overstated Ending Inventory Balances
o Unrecorded Accrued Expenses
o Unrecorded Accrued Income

NON-COUNTERBALANCING
• The error will be corrected only with adjusting entry. The statement of financial position
is inaccurate until the error is corrected. The statement of financial performance may
only be inaccurate during the period of error and accurate in succeeding periods.
Examples are:
o Understated or Overstated Depreciation Expense
o Erroneous Recording

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PROBLEM SOLVING
SECTION 1

PROBLEM 3

You are auditing the financial statements of Art Inc. for the year 2019. You made an
examination of its records to determine whatever adjustments and corrections are necessary.
Prior to any adjustments, the details of the company's Accumulated Profit account are as
follows:

Accumulated Profit
Date Particulars Debit Credit Balance
1/1/2017 Beginning balance 870,000
12/31/2017 2017 Net income 465,000 1,335,000
1/31/2018 Dividends paid 210,000 1,125,000
4/1/2018 Paid in capital in excess of par 135,000 1,260,000
8/30/2018 Gain on retirement of preference 96,750 1,356,750
12/31/2018 2018 Net loss 307,500 1,049,250
1/31/2019 Dividends paid 150,000 899,250
12/31/2019 2019 Net loss 248,250 651,000

a. The following were omitted at the end of each year:

2019 2018 2017 2016

Accrued Income 11,700 9,300 8,400 7,050
Unearned Income 14,400 13,350 11,700 10,350
Accrued expenses 13,500 13,050 10,950 8,100
Prepayments 14,250 11,100 9,300 12,750

b. Dividends declarations were not recorded until paid the following year. Dividends
declared in December 2019 but paid and recorded only the following year amounted to
Php125,000.

c. The company received transportation equipment as a donation from one of its

shareholders on September 30, 2018. As of the date of donation, the equipment has a
historical cost of Php1,125,000; a remaining useful life of 3 years and a fair value of
Php360,000. The only entry made at the date of donation was the entry expensing
Php45,000, which is the fee paid to affect the transfer of ownership.

d. The company purchased a machine worth Php405,000 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 of depreciation and the machine has an
estimated life of 3 years.

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AUDITING PROBLEM MODULE 01

e. The physical count of the merchandise inventory had been understated by Php96,000
and by Php66,750 at the end of 2017 and 2019, respectively.

f. The merchandise inventories at the end of 2018 and 2019 amounting to Php651,000
and Php48,900; respectively were erroneously not included in the physical count and
were likewise erroneously not recorded as purchases.

REQUIRED:

1. What is the correct accumulated profit as of December 31, 2016?

2. What is the correct net income for the year ended December 31, 2017?

3. What is the correct accumulated profit balance as of December 31, 2018?

4. What is the correct net loss for the year ended December 31, 2019?

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AUDITING PROBLEM MODULE 01

SOLUTION:

NET INCOME ACCUMULATED PROFITS

2016 2017 2018 2019 2016 2017 2018 2019
A) 465,000 (307,500) (248,250) 870,000 1,335,000 1,049,250 651,000
Accrued Income 7,050 (7,050) 7,050
8,400 (8,400) 8,400
9,300 (9,300) 9,300
11,700 11,700
Unearned Income (10,350) 10,350 (10,350)
(11,700) 11,700 (11,700)
(13,350) 13,350 (13,350)
(14,400) (14,400)
Accrued Expense (8,100) 8,100 (8,100)
(10,950) 10,950 (10,950)
(13,050) 13,050 (13,050)
(13,500) (13,500)
Prepayments 12,750 (12,750) 12,750
9,300 (9,300) 9,300
11,100 (11,100) 11,100
14,250 14,250
B) (210,000) (150,000) (125,000)
C) 45,000 45,000 45,000
(30,000) (30,000) (30,000)
(120,000) (120,000)

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AUDITING PROBLEM MODULE 01

D) 405,000 405,000 405,000 405,000 405,000

(90,000) (90,000) (90,000) (90,000) (90,000)
(135,000) (135,000) (135,000) (135,000)
(135,000) (135,000) (135,000)
(45,000) (45,000)
E) 96,000 (96,000) 96,000
66,750 66,750
F) 651,000 (651,000) 651,000
(651,000) 651,000 (651,000)
48,900 48,900
(48,900) (48,900)
Adjusted 316,350 419,700 (524,550) (342,450)
2) 4)
Adjustments
PIC - Excess of Par (135,000)
Gain on retirement (96,750)
Adjusted RE 1,186,350 1,396,050 721,500 485,800
1) 3)

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PROBLEM 6

H Co. has been using the FIFO method of inventory costing since it began operations in 2018. In
2020 the company changed to the weighted average method. The following are the December
31 inventory balances under each method:

YEAR FIFO WEIGHTED AVERAGE

2018 500,000 565,000
2019 450,000 560,000
2020 895,000 999,000

The effect on retained earnings as a result of making the change on January 1, 2020 is:

110,000 increase

ACTIVITIES AND REFERENCES

ACTIVITY 1:
Problem Solving for assessment of understanding.

REFERENCES:
PAS 8
Applied Auditing by Cabrera
Reviewers:
• Cabrera
• Roque
• Uberita
• Valix

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ACTIVITY 1
PROBLEM SOLVING

CONDITIONS FOR GRADED GROUP QUIZ:

1. Each group should solve every problem.

2. Ensure that everyone in the group understands the problem and the solution.
3. The items below will be treated as a group quiz.
4. I will call random names and ask questions related to the problems.
5. Every correct answer is treated as a score for the group. Illustration:
a. Group 1 with Members A, B, C, D, E, and F.
b. I ask question 1 to member A.
c. Member A answered incorrectly, therefore the group will not get the point even
if other members of the group know the correct answer.
d. If other groups that were not called got the correct answer, they will also get the
point.

PROBLEM 1

The first audit of the books of HUNTER Company was made for the year ended December 31,
2020. In reviewing the books, the auditor discovered that certain adjustments had either been
overlooked or improperly recorded at the end of 2018, 2019 and 2020. Gross profit is 20% of
sales. Errors are summarized below.

December 31
DESCRIPTIONS
2020 2019 2018
a. Omission of Accrued salaries expense 1,000 2,000 3,000
b. Omission of Unearned rent income 4,000 5,000 6,000
c. Omission of Accounts payable/Purchases 7,000 8,000 9,000
d. The ending inventory is overstated 10,000 11,000 12,000
e. Omission of Prepaid insurance 13,000 14,000 15,000
f. Omission of Accrued Interest Income 16,000 17,000 18,000

g. The ending inventory is understated as a result of

19,000 20,000 21,000
error in the count of goods on hand

h. Major expenditures had been recognized as repairs;

depreciation rate on such equipment is 20% per year, 22,000 23,000 24,000
but depreciation in the year of expenditure is at 10%.

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AUDITING PROBLEM MODULE 01

REQUIRED:

1. Prepare the audit adjustments assuming that the errors were discovered in your audit of
the books for the period ended Dec. 31, 2020.

2. Assuming the unadjusted net income for the years 2020, 2019 and 2018 were P1 M; P2
M and P3 M, respectively, compute for the adjusted net income.

3. If unadjusted retained earnings, end of the years 2020, 2019 and 2018 were P7 M; P8 M
and P9 M, respectively, compute for the adjusted retained earnings.

4. If unadjusted working capital, end for the years 2020, 2019 and 2018 were P4 M; P5 M
and P6 M, respectively, compute for the adjusted working capital.

PROBLEM 2

The December 31 year-end FS of ONE PIECE CO. contained the following errors:

December 31, 2017 December 31, 2018

Ending Inventory 48,000 Understated 40,500 Overstated
Depreciation expense 11,500 Understated 0

An insurance premium of P330, 000 was paid in advance in 2017 covering the years 2017, 2018
and 2019. The entire amount was charged to expense in 2017. In addition, on December 31,
2018, fully depreciated machinery was sold for P75, 000 cash but the sale was not recorded
until 2019. There were no other errors during 2017 and 2018, and no corrections have been
made for any of the errors. Ignore income tax effects.

1. What is the total effect of the errors on Sam's 2018 net income?

2. What is the total effect of the errors on Sam's working capital at Dec. 31, 2018?

3. What is the total effect of the errors on Sam's RE at Dec. 31, 2018?

PROBLEM 4

KUROKO CO. decided on January 2, 2018, to change the depreciation method of its equipment
from sum of the year's digits to straight line method of depreciation. Said equipment was
purchased on January 1, 2008 for Php1,150,000, total life of 15 years and a Php50,000 residual
value. As of January 2, 2018, the residual value remains at Php50,000, but with a revised
remaining useful life of 10 years.

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1. The depreciation expense for the current year is:

2. The carrying value of the equipment as of December 31, 2018 is:

PROBLEM 5

HAIKYU CO. decided to change its depreciation method for its equipment from straight-line to
sum of the years' digits beginning January 1, 2019. The equipment has a 1o% salvage value. and
an estimated useful life of 5 years. The following equipment acquisitions were made:

Date of Acquisition Acquisition Cost

1/1/2016 90,000
1/1/2017 50,000
1/1/2018 60,000

The correct depreciation expense for 2018 and 2019;

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