Applied Auditing by Cabrera

CHAPTER COMPREHENSIVE AUDIT OF BALANCE SHEET AND INCOME STATEMENT ACCOUNTS

23 23-1.

Daffodil, Inc. Adjusting Journal Entries 12.31.16 AJE (1)

(2)

Share donation Treasury shares Land Building

35,000 10,000 15,000

Accumulated depreciation - machinery Loss on sale of machinery Machinery Cost Less: AD (20%) NBV Proceeds Loss

(3)

60,000

(b) Factory operating expenses Accumulated depreciation - building Accumulated depreciation - machinery

(4)

3,000

P 5,000 1,000 P 4,000 2,000 P 2,000

(a) Accumulated depreciation - building Retained earnings

Building (P315,000 x 2%) Machinery: 5,000 x 10% = 145,000 x 10% =

1,000 2,000

300 300 21,300 6,300 15,000

P 500 14,500 P15,000

Merchandise inventory, 12.31.16 B/S Merchandise inventory, 12.31.16 I/S

175,000 175,000

23-2

Applied Auditing 2014 Edition Solutions Manual (5)

(6)

(7)

(8)

(9)

Administrative expenses Allowance for doubtful accounts

1,000

Factory operating expenses Unexpired insurance

3,000

Retained earnings Bond interest expense Unamortized bond discount

2,500 2,500

Sinking fund assets First Mortgage SF Bonds Sinking fund assets Sinking fund income

1,000

3,000

5,000 23,500 23,500 1,500 1,500

Comprehensive Audit Cases and Problems 23-1.

23-3

Daffodil, Inc. (continued) Daffodil, Inc. Working Trial Balance 12.31.16

Cash Accounts receivable Provision for doubtful accounts Inventories, 12.31.15 Unexpired insurance, 12.31.15 Land Buildings Accumulated Depreciation - Buildings Machinery Accumulated Depreciation - Machinery Sinking fund assets Unamortized bond discount Treasury shares, ordinary Accounts payable Bond interest accrued 1st Mortgage, 6% SF Bonds Ordinary shares Premium on ordinary shares Share donation Retained earnings, 12.31.15 Sales Purchases Payroll Factory operating expenses Administrative expenses Bond interest expense Loss on sale of machinery Merchandise inventory 12.31.16 Sinking fund income

Trial Balance Dr Cr P 64,000 200,000 P 1,000 223,000 6,000 220,000 330,000 6,600 148,000 15,000 25,000

Adjustments Dr

283,500 169,000 121,500

(3a) (2) (8) (9)

300 1,000 23,500 1,500

(1) (7)

60,000 2,500

(6) (1) (1) (3b) (2) (3b)

3,000 10,000 15,000 6,300 3,000 15,000

(7) (1)

5,000 35,000

(8)

23,500

(3a)

3,000 210,000 315,000 12,600 145,000 29,000 50,000 20,000 88,000 3,750 250,000 500,000 50,000 71,950

300 P 875,000

(3b) (6) (5)

21,300 3,000 1,000

145,800 36,000

(7)

2,500

17,500

(2) (4)

2,000 175,000

P1,900,000

P 293,600 Net Income

1,000

283,500 169,000

35,000 15,000 P1,900,000

(5)

Balance Sheet Dr Cr P 64,000 200,000 P 2,000

P 223,000

25,000 35,000 88,000 3,750 226,500 500,000 50,000 60,000 74,150 875,000

Income Statement Dr Cr

Cr

2,000 (4) (9)

175,000 1,500 P 293,600

175,000 1,500

175,000

P 876,800 174,700

P1,051,500

P1,182,000

P1,007,300 174,700

P1,051,500

P1,051,500

P1,182,000

P1,182,000

23-4

Applied Auditing 2014 Edition Solutions Manual

23-2. Part I

Adjusting Journal Entries, 12-31-14

AJE (1)

Depreciation expense Accumulated depreciation

1,778 1,778

[(P22,000 – P2,000) – P4,000] 9 (2)

(3)

(4) (5) (6)

(7)

(8) (9)

Prepaid interest Retained earnings Interest expense Merchandise inventory, 12-31-16 BS Merchandise inventory, 12-31-16, IS or Cost of Sales

3,100 1,900 15,000 15,000

Retained Earnings Purchases

6,000

Prepaid insurance Insurance expense

3,000

Store supplies inventory Store supplies expense Retained earnings

1,450

6,000 3,000 550 900

Retained earnings Commissions expense Accrued commissions payable

730 240

Cash in bank Miscellaneous income

650

Purchases Accounts payable

800

(10) Income from Investment Investment (11) Prepaid advertising and promotions Advertising and promotions expense (12)

5,000

970 650 800 3,000 3,000 90,000 90,000

NO AJE

(13) Machinery Depreciation expense – machinery Allowance for depreciation – machinery Repairs and maintenance

20,000 167 167 20,000

Comprehensive Audit Cases and Problems (14) Miscellaneous income Gain on sale of treasury shares Land Additional paid-in capital arising from Treasury Share transactions

2,000 5,000

(15) Doubtful accounts expense Allowance for uncollectible accounts

14,500

Required allowance as of 12-31-07 – on past due accounts (5% x P30,000) – on current accounts (1% x P400,000) Total Unadjusted debit balance of the “Allowance” account Additional Provision

23-5

2,000 5,000 14,500

P 1,500 4,000 P 5,500 9,000 P14,500

Part II Column B – Adjustment, 12-31-16 AJE (a)

Retained earnings Purchases

xx

(b)

NONE

xx

(c)

Retained Earnings Allowance for depreciation

xx

Retained Earnings Allowance for depreciation

xx

Machinery Retained earnings

xx

Depreciation Allowance for depreciation

xx

Retained earnings Taxes

xx

xx

xx

(d)

(e)

(f)

(g)

23-3.

xx

xx

xx

xx

xx

International Company AJE (1)

(2)

Depreciation expense Accumulated depreciation – delivery vehicle Cost of sales Retained earnings

3,200 3,200 19,000 19,000

23-6

Applied Auditing 2014 Edition Solutions Manual (3)

(4)

(5)

(6)

(7)

(8)

(9)

Cost of sales Inventory

8,500

Cash Accounts receivable

5,600

Accumulated depreciation – equipment Equipment Gain on sale of equipment Estimated litigation loss Estimated litigation liability

8,500

5,600 22,000 18,300 3,700 125,000 125,000

Unrealized holding gain or loss – Income Allowance for decline in value of securities

2,000

Accrued salaries payable Salaries expense

3,800

Depreciation expense Equipment Repairs expense Accumulated depreciation – equipment

(10) Insurance expense Prepaid insurance Retained earnings

2,000

3,800 4,000 32,000 32,000 4,000 5,000 7,000 12,500

(11) No adjusting entry. Trademark has indefinite life and no amortization need be made. 23-4.

Sunshine Cosmetics, Inc. Requirement (1) AJE (1)

(2)

(3)

Inventory, Dec. 31, 2015 (BS) Inventory, Dec. 31, 205 (IS) or Cost of sales

67,200

Doubtful accounts expense Allowance for doubtful accounts (15,660 – 740)

14,920

Accounts payable Purchase returns and allowances

20,760

67,200

14,920

20,760

Comprehensive Audit Cases and Problems (4)

(5)

(6)

(7)

(8)

(9)

Sales commissions Accrued commissions payable

23-7

216 216

Freight-in Accounts payable

1,600

Advertising expense Prepaid advertising

1,212

Freight-out or Expense Sales

8,400

Interest receivable Interest income

1,380

Depreciation expense Accumulated depreciation

1,300

1,600

1,212

8,400

1,380

1,300

(10) Supplies expense Unused Supplies

1,160 1,160

(11) Provision for Income tax expense Income tax payable

107,386 107,386

Requirement (2) Sunshine Cosmetics, Inc. Income Statement For the Year Ended December 31, 2015 Revenue from sales: Sales Less: Sales returns and and allowances Sales discounts Cost of goods sold: Inventory, January 1 Net purchases: Purchases Less purchase returns and allowances Freight-in Cost of goods available for sale Less Inventory, December 31 Gross profit on sales

P998,800 (a) P 22,400 1,760

24,160

P974,640

P179,400 P346,000 20,760 (c)

325,240 12,650 (b) P517,290 108,300 (d)

408,990 P565,650

23-8

Applied Auditing 2014 Edition Solutions Manual Other income: Interest revenue Dividend revenue Gain on sale of assets Total income Operating expenses: Selling expenses: Sales salaries and commissions Advertising expense Depreciation expense – Sales/delivery equipment Freight expense Travel expense – sales representatives Miscellaneous selling expenses General and administrative expenses: Legal services Insurance and licenses Depreciation expense – office equipment Utilities Telephone and postage Supplies expense Officers’ salaries Doubtful accounts expense Total operating expenses Other expense and losses: Interest expense Loss on sale of equipment Income from continuing operations before income taxes Income taxes Income from continuing operations Discontinued operations: Gain from discontinued operations (net of income taxes of P25,600) Net income

P

2,780 (i) 14,300 37,000

54,080 P619,730

P 70,216 (e) 33,392 (f) 13,500 (g) 8,400 9,120 4,400

P

P139,028

4,450 17,000 9,600 12,800 2,950 1,160 (k) 73,200 14,920 (h)

136,080 (275,108) P

9,040 45,200

(54,240) P290,382 92,922 (j) P197,460

54,400 P251,860

Comprehensive Audit Cases and Problems Earnings per ordinary share: Income from continuing operations (P197,460  78,000 shares) Gain from discontinued operations (P54,400  78,000 shares) Net income (P251,860  78,000 shares)

23-9

P2.53 0.70 P3.23

Computations: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)

Sales: P990,400 + P8,400 = P998,800 Freight-in: P11,050 + P1,600 = P12,650 Purchase returns and allowances: P346,000 x 6% = P20,760 Inventory: P41,100 + P67,200 = P108,300 Sales salaries and commissions: P70,000 + (P7,200 x 3%) = P70,216 Advertising expense: P32,180 + (P3,636 x 2/6) = P33,392 Depreciation expense: P12,200 + (P15,600 x 10/120) = P13,500 Doubtful accounts expense: (P522,000 x 3%) – P740 = P14,920 Interest revenue: P1,400 + P1,380 = P2,780 Income taxes: P335,582 x 32% = P107,387 Supplies expense: P4,360 – P3,200 = P1,160 Sunshine Cosmetics, Inc. Retained Earnings Statement For the Year Ended December 31, 2015

Retained earnings, January 1 Add net income per income statement

P 881,340 251,860 P1,133,200 66,000 P1,067,200

Deduct dividends paid Retained earnings, December 31 23-5.

Del Bakery Working papers are not required, but they facilitate the preparation of a corrected balance sheet. Del Bakery Working Papers for Corrected Balance Sheet December 31, 2016 Account Title Current Assets ..................... Current Liabilities ................. Other Assets ........................ Other Liabilities .................... Investment in Business ........

Balance Sheet Debit Credit 53,415 .............. ............. 29,000 75,120 .............. ............. 3,600 ............. 95,935 128,535 128,535

Corrections Debit Credit .............. (a) 53,415 (c) 29,000 ............. .............. (b) 75,120 (d) 3,600 ............. (e) 95,935 ............. .............. .............

Corrected Balance Sheet Debit Credit ............. .............. ............. .............. ............. .............. ............. .............. ............. .............. ............. ..............

23-10

Applied Auditing 2014 Edition Solutions Manual Cash ..................................... Investment Securities – trading (at market value) .... Trade Accounts Receivable . Inventory............................... Supplies Inventory................ Delivery Truck ...................... Fixtures................................. Accumulated Depreciation – Fixtures............................... Cash Surrender Value of Insurance on Officers’ Lives ................................... Retained Earnings................

Land ..................................... Buildings ............................... Accumulated Depreciation – Buildings [2 ½ (P62,000  20)] 11% Mortgage Payable ........ 11% Mortgage Payable (current portion).................. Interest Payable ................... Trade Accounts Payable ...... Miscellaneous Liabilities ...... Share Capital, P5 stated value, 5,000 shares ............ Paid-in Capital from Sale of Shares at More Than Stated Value.......................

Corrections:

(a) (b) (c)

.............

..............

(a) 10,600

.............

10,600

..............

............. ............. ............. ............. ............. .............

.............. .............. .............. .............. .............. ..............

(a) (a) (a) (a) (a) (a)

............. ............. ............. ............. ............. .............

2,575 12,500 8,040 425 2,100 12,500

.............. .............. .............. .............. .............. ..............

.............

..............

..............

(a) 2,100

.............

2,100

............. ............. ............. ............. ............. ............. .............

.............. .............. .............. .............. .............. .............. ..............

(a) 4,100 (a) 2,675 (b) 7,750 (d) 350 .............. (b) 30,000 (b) 62,000

............. ............. ............. ............. (e) 40,935 ............. .............

4,100 ............. ............. ............. ............. 30,000 62,000

.............. .............. .............. 30,160 .............. .............. ..............

............. .............

.............. ..............

.............. ..............

(b) 7,750 (b) 12,000

............. .............

7,750 12,000

............. ............. ............. .............

.............. .............. .............. ..............

.............. .............. .............. ..............

(b) 4,000 (b) 880 (c) 29,000 (d) 3,950

............. ............. ............. .............

4,000 880 29,000 3,950

.............

..............

..............

(e) 25,000

.............

25,000

.............

..............

.............. 284,150

(e) 30,000 284,150

............. 144,840

30,000 144,840

To restate current assets To restate other assets To restate current liabilities

2,575 12,500 8,040 425 2,100 12,500

(d) (e)

To restate other liabilities To restate owners’ equity accounts

Del Bakery Corrected Balance Sheet December 31, 2016 Assets Current assets: Cash ........................................................................ Investment securities – trading (reported at market; cost P4,250) ......................................... Trade accounts receivable (fully collectible) .......... Inventory................................................................. Supplies inventory ..................................................

P10,600 2,575 12,500 8,040 425

P 34,140

Comprehensive Audit Cases and Problems Investments: Cash surrender value of life insurance .................... Land, buildings and equipment: Land ........................................................................ Buildings.................................................. P62,000 Less accumulated depreciation .......... 7,750 Fixtures .................................................... P12,500 Less accumulated depreciation .......... 2,100 Delivery truck ......................................................... Total assets ................................................................... Liabilities Current liabilities: Mortgage payable, portion due this year ................ Accounts payable .................................................... Interest payable ....................................................... Miscellaneous accrued liabilities ............................ 11% Mortgage payable (noncurrent portion) ............... Total liabilities.............................................................. Owners’ Equity Contributed capital: Share capital, P5 stated value, 5,000 shares ....................................... P25,000 Paid-in capital from sale of ordinary shares at more than stated value ........................................ 30,000 Retained earnings ......................................................... Total owners’ equity..................................................... Total liabilities and owners’ equity .............................. 23-6.

23-11 4,100

P30,000 54,250 10,400 2,100

P 4,000 29,000 880 3,950

96,750 P134,990

P 37,830 12,000 P 49,830

P55,000 30,160 85,160 P134,990

Masipag Corporation Adjusting Journal Entries, Dec. 31, 2016 AJE (1)

(2)

(3)

Cash Accounts payable Accounts receivable Cash Bank loan payable Other expenses Cash

200,000 200,000 10,000 10,000 400,000 12,500 412,500

23-12

Applied Auditing 2014 Edition Solutions Manual (4) (5) (6) (7)

(8) (9)

Cash Accounts receivable

75,000 75,000

Operating expenses Cash

1,500

Cash Other income

16,000

Accounts receivable – others (2,000 + 3,000) Operating expenses Cash

1,500 16,000 5,000 2,000 7,000

Marketable securities Other income

40,000

Other income Marketable securities

54,000

(10) Marketable securities Other income (10.a) Valuation allowance – Marketable securities – Trading Other income – Unrealized holding gain

40,000 54,000 32,000 32,000 145,600 145,600

(11) Sales Accounts receivable

500,000

(12) Inventory Cost of sales

400,000

500,000 400,000

(13) Accounts receivable – others (30,000 – 15,000) Accounts receivable

15,000

(14) Accounts receivable – others Accounts receivable

55,000

(15) Accounts receivable Other current liabilities

50,000

(16) Operating expenses Allowance for doubtful accounts

21,900

(17) Other income Discount on notes receivable

54,545

(18) Discount on notes receivable Other income

15,000 55,000 50,000 21,900 54,545 4,545 4,545

Comprehensive Audit Cases and Problems (19) Cost of sales Accounts payable

60,000

(20) Cost of sales Accounts payable

25,000

(21) Inventory Cost of sales

25,000

(22) Accounts receivable – others Inventory

16,000

(23) Sales Accounts receivable

13,000

(24) Operating expenses Prepaid expenses

46,250

(25) Operating expenses Prepaid expenses

5,000

(26) Other assets Operating expense Prepaid expenses

60,000 120,000

23-13 60,000

25,000

25,000

16,000

13,000

46,250

5,000

180,000

(27) Long-term bond investment Other income

5,777

(28) Accounts receivable – others Other income

5,333

5,777

5,333

(29) Land Building Land and building

1,062,500 3,187,500

(30) Building Land and building

425,000

(31) Operating expenses Land and building

20,000

(32) Operating expenses Prepaid expenses Land and building

27,500 27,500

4,250,000

425,000

20,000

55,000

23-14

Applied Auditing 2014 Edition Solutions Manual (33) Land and building Operating expenses Accumulated depreciation – building

237,500 115,578 121,922

(34) Prepaid expenses Operating expenses Equipment

10,000 10,000

(35) Operating expenses Accumulated depreciation – equipment

55,400

(36) Accounts payable Other current liabilities

50,000

(37) Operating expenses Estimated liability on warranties

15,000

(38) Other current liabilities Other expenses

50,000

20,000

55,400

50,000

15,000

50,000

(39) Income taxes payable Provision for income tax

115,290 115,290

MASIPAG CORPORATION Balance Sheet December 31, 2016 Assets Current assets Cash Marketable securities Valuation allowance Accounts receivable Allowance for doubtful accounts Notes receivable Discount on notes receivable Accounts receivable – others Inventory, December 31, 2007 Prepaid expenses Total current assets Investments Long-term bond investment Property, plant and equipment Land Building Accumulated depreciation – Building

P P 400,000 145,600 P 442,000 (33,150) P 600,000 (50,000)

734,000 545,600 408,850 550,000 96,333 1,960,500 175,250 P4,470,533 744,077

P1,062,500 P3,612,500 (121,922)

3,490,578

Comprehensive Audit Cases and Problems Equipment Accumulated depreciation – Equipment

P1,654,000 (235,400)

23-15

1,418,600

Total property, plant and equipment Other assets Total assets

5,971,678 110,000 P11,296,288

Liabilities and Shareholders’ Equity Current liabilities Accounts payable Bank loan payable Accrued expenses payable Other current liabilities Income taxes payable Estimated liability on warranties Total current liabilities

P 877,000 1,100,000 59,000 100,000 130,558 70,000

Shareholders’ equity Ordinary shares Additional paid-in capital Retained Earnings Total shareholders’ equity Total liabilities and shareholders’ equity

P5,000,000 1,655,250 2,304,480

P 2,336,558

8,959,730 P11,296,288

MASIPAG CORPORATION Income Statement For the Year Ended December 31, 2016 Sales Cost of sales Gross profit Other income Operating expenses Other expenses Income before taxes Provision for income tax Net Income

23-7.

P 6,437,000 (4,060,000) P 2,377,000 225,710 (1,511,509) (37,500) P 1,053,701 (342,441) P 711,260

Felicity Company Adjusting Journal Entries, Dec. 31, 2016 AJE (1)

Cash Prepaid interest Other charges Long-term debt (current portion) Long-term debt

31,000 3,000 2,000 24,000 12,000

23-16

Applied Auditing 2014 Edition Solutions Manual (2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

Cash Accounts payable and others

2,000 2,000

Investments in SMC shares – available for sale (non-current) Marketable securities

72,000

Unrealized loss due to decline in value of non-current investment (equity) Operating expenses

20,000

Allowance for doubtful accounts Operating expenses Accounts receivable Operating expenses

72,000

20,000 41,100 41,100 8,000 8,000

Inventory Cost of sales

12,000

Sales Accounts receivable

14,400

Revaluation increment Accumulated depreciation Property and equipment

12,000

14,400 120,000 80,000 200,000

(10) Accumulated depreciation Operating expenses

36,000

(11) Operating expenses Accumulated depreciation

48,000

(12) Revaluation increment Retained earnings

24,000

(13) Property and equipment Operating expenses

30,000

(14) Retained earnings Cumulative effect of change in accounting principle

13,000

(15) Accounts receivable – others Cash

22,000

36,000

48,000

24,000

30,000

13,000

22,000

Comprehensive Audit Cases and Problems (16) Provision for income tax Income tax payable

23-17

25,445 25,445

FELICITY COMPANY Balance Sheet December 31, 2016 Assets Current Assets: Cash............................................................................................ Accounts receivable ................................................................... Allowance for doubtful accounts ............................................... Accounts receivable -others ....................................................... Inventories .................................................................................. Prepaid interest ........................................................................... Non-current Assets: Advances to affiliate .................................................................. Investments in SMC shares – available for sale ......................... Allowance for decline in value of non-current investment ........ Property and equipment ............................................................. Accumulated depreciation .......................................................... Total Assets

P

123,600 1,751,820 (27,000) 62,000 262,000 3,000

48,000 72,000 (20,000) 2,600,000 (1,172,000) P 3,703,420

Liabilities and Shareholders’ Equity Accounts payable and others (including current portion of bank loan of P24,000) ............................................................... Income tax payable ............................................................................ Long-term debt .................................................................................. Ordinary share capital ....................................................................... Retained earnings .............................................................................. Unrealized loss due to decline in value of investment in SMC ......... Revaluation increment ....................................................................... Total Liabilities and Shareholders’ Equity

P

434,616 100,205 72,000 2,042,000 978,599 (20,000) 96,000 P 3,703,420

FELICITY COMPANY Income Statement For the Year Ended December 31, 2016 Sales .................................................................................................. Cost of sales ...................................................................................... Gross profit ........................................................................................ Operating expenses ........................................................................... Other charges.....................................................................................

P 2,757,124 2,257,604 P 499,520 (83,522) (102,000)

23-18

Applied Auditing 2014 Edition Solutions Manual Income from continuing operations before tax .................................. Provision for income tax (35%) ........................................................ Income from continuing operations after tax .................................... Discontinued operations (net) ........................................................... Net income ........................................................................................

23-8.

P

313,998 109,899 204,099 (6,500) 197,599

P P

Learn Company Condensed Comparative Income Statements

Construction revenue Construction expense Other expenses Income before income taxes Income tax expense Net income

2018

2017

2016

P900,000 (420,000) (80,000) P400,000 (120,000) P280,000

P420,000 (182,000) (70,000) P168,000 (50,400) P117,600

P200,000 (80,000) (50,000) P 70,000 (21,000) P 49,000

Comparative Statements of Retained Earnings 2018 Balance at beginning of year, as previously reported Add: Adjustment for the cumulative effect on prior years of applying retroactively the new method of accounting for long-term contracts (net of income taxes) Balance at beginning of year, as adjusted Net income Balance at end of year

2017

P 77,000

89,600

P

b

2016

7,000

42,000

P

a

0

0

P166,600

P 49,000

P

0

280,000

117,600

49,000

P446,600

P166,600

P 49,000

Note: The company has accounted for revenue and costs for long-term construction contracts by the percentage-of-completion method in 2018, whereas in prior years revenues and costs were determined by the completed-contract method. The new method of accounting for long-term contracts was adopted to (state justification for change in accounting principle) and financial statements of prior years have been restated to apply the new method retroactively. The effect

Comprehensive Audit Cases and Problems

23-19

of the accounting change on income of 2018 and on income as previously reported in 2016 and 2017 is as follows:

Net income Earnings per ordinary share

2018 P112,000 P11.20

c

Increase 2017 P47,600 P4.76

2016 P42,000 P4.20

The balances of retained earnings for 2008 and 2009 have been adjusted for the after-tax effect of applying the new method of accounting retroactively.

23-9.

a

P49,000 – P7,000

b

(P49,000 + P117,600) – (P7,000 + P70,000)

c

P280,000 – [(P600,000 – P280,000 – P80,000) x (1 – 0.30)]

Goody Construction Company Requirement (1) 2016 Jan. 1

Construction in Progress Retained Earnings [P70,000 x (1 – 0.30)] Deferred Tax Asset a [(P100,000 + P120,000) + (P125,000 + P75,000)] – (P100,000 + P250,000)

70,000 a 49,000 21,000

Requirement (2) GOODY CONSTRUCTION COMPANY Condensed Comparative Income Statements (Partial)

Income before income taxes Income taxes at 30% Net income Earnings per ordinary share (100,000 shares)

2016 P400,000 (120,000) P280,000

P2.80

2015 P200,000 (60,000) P140,000

P1.40

2014 P220,000 (66,000) P154,000

P1.54

23-20

Applied Auditing 2014 Edition Solutions Manual Comparative Statements of Retained Earnings 2016 Balance at beginning of year, as previously reported Add: Adjustment for the cumulative effect on prior years of applying retroactively applying the new method of accounting for long-term contracts (net of income taxes) Balance at beginning of year, as adjusted Net income Balance at end of year

2015

2014

P245,000

c

P 70,000

b

49,000

e

84,000

d

P294,000 280,000 P574,000

P154,000 140,000 P294,000

P

0

0 P 0 154,000 P154,000

b

P100,000 x (1 – 0.30)

c

P250,000 x (1 – 0.30) + P70,000

d

[(P100,000 + P120,000) – P100,000] x (1 – 0.30)

e

[(P100,000 + P120,000 + P125,000 + P75,000) – (P100,000 + P250,000)] x (1 – 0.30)

Note: The company has accounted for revenue and costs for long-term construction contracts by the percentage-of-completion method in 2007, whereas in prior years revenues and costs were determined by the competed-contract method. The new method of accounting for long-term contracts was adopted to (state justification for change in accounting principle) and financial statements of prior years have been restated to apply the new method retroactively. The effect of the accounting change on income of 2016 and on income as previously reported in 2014 and 2015 is as follows:

Net income Earnings per ordinary share

2016 P(49,000) P(0.49)

h

Increase 2015 P(35,000) P(0.35)

g

2014 P84,000 P0.84

f

The balances of retained earnings and deferred taxes for 2015 and 2016 have been adjusted for the after-tax effect of applying the new method of accounting retroactively: f

(P220,000 – P100,000) x (1 – 0.30)

g

(P200,000 – P250,000) x (1 – 0.30)

h

[P400,000 – (P820,000 – P350,000)] x (1 – 0.30)

Comprehensive Audit Cases and Problems

23-21

Items Restated: On the 2014 and 2015 income statements, construction revenues and expenses would be restated to the appropriate amounts for the percentage of completion method. The construction in progress, deferred income taxes, and retained earnings on the balance sheets would also be restated. 23-10.

Sand Company Requirement (1) a.

Incorrect entries: Building Notes Payable Depreciation Expense: Building (P60,000  30) Accumulated Depreciation: Building Correct entries: Building Discount on Notes Payable Notes Payable a

60,000 2,000 2,000

40,981 19,019

a

60,000

P60,000 x 0.683013

Depreciation Expense: Building Interest Expense Accumulated Depreciation Discount on Notes Payable b

P40,981  30

c

Interest computed using effective interest method: 10% x P40,981

Entries to correct error: Discount on Notes Payable Building Accumulated Depreciation: Building Interest Expense Depreciation Expense: Building Discount on Notes Payable b.

60,000

Retained Earnings Cost of Goods Sold To correct error from prior year.

1,366 4,098

b c

1,366 4,098

19,019 19,019 634 4,098 634 4,098 40,000 40,000

23-22

Applied Auditing 2014 Edition Solutions Manual Cost of Goods Sold Inventory To correct error in current year. c.

15,000 15,000

The error from 2014 was counterbalanced at the end of 2015, so it can be ignored. Retained earnings Salaries and Wages Expense To correct error in salary and wage accrual in 2015.

18,000

Salaries and Wages Expense Salaries and Wages Payable To accrue salaries and wages at December 31, 2016.

10,000

18,000

10,000

Requirement (2) a.

See Requirement 1.a. of this solution for the incorrect entries that were made and the correct entries that should have been made. Discount on Notes Payable (total discount of P19,019 less amount of P4,098 amortized for 2016) Accumulated Depreciation: Building Retained Earnings Building d

b.

d

19,019

Correction of interest expense understatement of P4,098 less depreciation overstatement of P634

The error from 2015 was counterbalanced by the end of 2014, so it can be ignored. Retained Earnings Inventory

c.

14,921 634 3,464

15,000 15,000

The errors from 2014 and 2015 were counterbalanced by the end of 2015 and 2016; respectively, so they can be ignored. Retained Earnings Salaries and Wages Payable

10,000 10,000

Comprehensive Audit Cases and Problems 23-11.

23-23

Play Company Requirement (1) SFAS No. 13 paragraphs 42 and 43 state that “a change in accounting policy should be applied retroactively unless the amount of any resulting adjustment that relates to prior periods is not reasonably determinable. Any resulting adjustment should be reported as an adjustment to the opening balance of retained earnings. Comparative information should be restated unless it is impracticable to do so. The financial statements, including the comparative information for prior periods, are presented as if the new accounting policy had always been in use. Therefore, comparative information is restated in order to reflect the new accounting policy. The amount of the adjusting relating to periods prior to those included in the financial statements is adjusted against the opening balance of retained earnings of the earliest period presented. Any other information with respect to prior periods, such as historical summaries of financial data, is also restated.” PLAY COMPANY Worksheet to Correct Income Before Income Taxes

Income before income taxes, before adjustments Adjustments: Depreciate certain equipment over 8-year life instead of 10-year life (Schedule 1) Correct 2015 error Record 2016 provision for doubtful accounts (P58,500,000 x 0.2%) Increase estimated warranty liability Effect of change in accounting principle from expensing to capitalizing relining costs in the year of the change (Schedule 2) Furnace A (Jan. 2015) Furnace B (Jan. 2016) Net adjustments Income before income taxes

Year Ended December 31 2016 2015 P4,030,000 P3,330,000

(25,000) 180,000 (117,000) (170,000)

(56,000) 240,000 52,000 P4,082,000

-(180,000) ---

224,000 -44,000 P3,374,000

Schedule 1: Computation of Adjusted Depreciation Cost of equipment (no salvage value)

P1,000,000

Depreciation based on 10-year life Depreciation based on 8-year life Adjustment

P 100,000 (125,000) P (25,000)

23-24

Applied Auditing 2014 Edition Solutions Manual Schedule 2: Computation of Effect of Change in Accounting Principle From Expensing to Capitalizing Relining Costs on the Year of the Change Capitalization of Furnace B Depreciation on Furnace B based on 5-year life (P300,000 x 20%) Depreciation on Furnace A based on 5-year life (P280,000 x 20%) Adjustment

P300,000 (60,000) (56,000) P184,000

Requirement (2) PLAY COMPANY Effect Before Income Taxes of Change in Accounting Principle From Expensing to Capitalizing Relining Costs For Year Ended December 31, 2016 Capitalization of Furnace A Depreciation on Furnace A based on 5-year life (P280,000 x 20%) Adjustment 23-12.

P280,000 (56,000) P224,000

Jo Francisco, Inc.

Item 1. 2. 3. 4. 5. 6.

Net Income for 2014 Understated Overstated P14,100 0 P 7,000 0 0 P22,000 P33,000 0 0 P20,000 P18,200 0

Retained Earnings 12/31/15 Understated Overstated 0 0 P 5,000 0 0 P11,000 P33,000 0 0 P10,000 0 0

Although explanations were not required in answering the question, they are included below for your interest. Explanations: 1.

The net income would be understated in 2014 because interest income is understated. The net income would be overstated in 2015 because interest income is overstated. The errors, however, would counterbalance (wash) so that the Balance Sheet (Retained Earnings) would be correct at the end of 2015.

Comprehensive Audit Cases and Problems

23-13.

23-25

2.

The depreciation expense in 2014 should be P1,000 for this machine. Since the machine was bought on July 1, 2014, only one-half of a year should be taken in 2014 (P8,000/4 X 1/2 = P1,000). The company expensed P8,000 instead of P1,000 so net income is understated by P7,000 in 2015. An additional P2,000 of depreciation expense should have been taken in 2015. At the end of 2015, retained earnings would be understated by P5,000 (P7,000 – P2,000).

3.

PAS 38, paragraphs 54 to 57 govern the accounting for research and development costs. Net income in 2014 is overstated P22,000 (P33,000 research and development costs capitalized less P11,000 amortized). By the end of 2015, only P11,000 of the research and development costs would remain as an asset. Therefore, retained earnings would be overstated by P11,000 (P33,000 research and development costs – P22,000 amortized).

4.

The security deposit should be a long-term asset, called refundable deposits. The P8,000 of last month’s rent is also an asset, called prepaid rent. The net income of 2014 is understated by P33,000 (P25,000 + P8,000) because these amounts were expensed. Retained earnings will continue to be understated by P33,000 until the last year of the lease. The security deposit will then be refunded, and the last month’s rent should be expensed.

5.

P10,000 or one-third of P30,000 should be reported as income each year. In 2014, P30,000 was reported as income when only P10,000 should have been reported. Because P20,000 too much was reported, the net income of 2014 is overstated. At the end of 2015, P20,000 should have been reported as income, so retained earnings is still overstated by P10,000 (P30,000 – P20,000).

6.

The ending inventory would be understated since the merchandise was omitted. Because ending inventory and net income have a direct relationship, net income in 2014 would be understated. The ending inventory of 2014 becomes the beginning inventory of 2015. If beginning inventory of 2015 is understated, then net income of 2015 is overstated (inverse relationship). The omission in inventory over the two-year period will counterbalance, and retained earnings at the end of 2015 will be correct.

JC Patrick Corporation

Net income, as reported Rent received in 2015, earned in 2016 Wages not accrued, 12/31/14 Wages not accrued, 12/31/15 Wages not accrued, 12/31/16 Inventory of supplies, 12/31/14 Inventory of supplies, 12/31/15 Inventory of supplies, 12/31/16 Corrected net income

2015 P29,000 (1,300) 1,100 (1,500) (1,300) 740 P26,740

2016 P37,000 1,300 1,500 (940) (740) 1,420 P39,540