Correction of Errors

CHAPTER 2 – Accounting for Correction of Errors Exercises 1. On November 1, 2006, Rosete Company paid P10,800 to renew its insurance policy for 3 years. On December 31, 2006, Rosete’s unadjusted trial valance showed a balance of P270 for prepaid insurance and P13,230 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Rosete’s December 31, 2006 financial statements? Prepaid Insurance Insurance Expense a. P 9,900 P 3,600 b. P 10,200 P 3,600 c. P 10,200 P 3,300 d. P 10,200 P 3,030 2. An analysis of Palmes Corporation’s unadjusted prepaid expense account at December 31, 2006 revealed the following:   

An opening balance at P6,000 for Palmes comprehensive insurance policy. Palmes had paid an annual premium of P12,000 on July 1, 2005. A P12,800 annual insurance premium payment made July 1, 2006. A P8,000 advance rental payment for a warehouse Palmes leased for 1 year beginning January 1, 2006.

In its December 31, 2006 balance sheet, what amount should Palmes report as prepaid expenses? a. P 20,400 b. P 14,400 c. P 8,000 d. P 6,400 3. On October 1, 2006, a company sold services to a customer and accepted a note in exchange with a P120,000 face value and an interest rate of 10%. The note requires that both the principal and interest be paid at the maturity date, December 1, 2007. The company’s accounting period is the calendar year. What adjusting entry (related to this note) will be required at December 31, 2006 on the company’s books? a. Deferred interest income 3,000 Interest receivable b. Interest income 3,000 Interest receivable c. Interest receivable 3,000 Deferred interest income d. Interest receivable 3,000 Interest income

3,000 3,000 3,000 3,000

4. What is the purpose of the following entry? Supplies xxxx Supplies expense

xxxx

a. To recognize supplies used, if purchases of supplies are recorded in supplies. b. To recognize supplies on hand, if purchases of supplies are recorded in supplies expense.

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c. To record the purchase of supplies during or at the end of the period. d. To close the expense account for supplies at the end of the period. 5. On December 31, earned but unpaid wages amounted to P15,000. What reversing entry could be made on January 1? a. Wages expense 15,000 Wages payable 15,000 b. Prepaid expense 15,000 Wages expense 15,000 c. Wages expense 15,000 Prepaid wages 15,000 d. Wages payable 15,000 Wages expense 15,000 6. A 3-year insurance policy was purchased on October1 for P6,000, and prepaid insurance was debited. Assuming a December 31 year-end, what is the reversing entry at the beginning of the next period? a. None is required. b. Cash 6,000 Prepaid insurance 6,000 c. Prepaid insurance 5,500 Insurance expense 5,500 d. Insurance expense 500 Prepaid insurance 500 7. A consulting firm started and completed a project for a client in December 2006. The project has not been recorded on the consulting firm’s books, and the firm will not receive payment from the client until February 2007. The adjusting entry that should be made on the books of the consulting firm on December 31, 2006, the last day of the firm’s fiscal year, is a. Cash in transit xxx Consulting revenue xxx b. Consulting revenue receivable xxx Consulting revenue xxx c. Unearned consulting rev. xxx Consulting revenue xxx d. Consulting revenue receivable xxx Unearned consulting revenue xxx 8. Cristie Company sublet a portion of its warehouse for 5 years at an annual rental of P15,000, beginning on March 1. The tenant paid 1 year’s rent in advance, which Cristie recorded as a credit to calendar-year basis. The adjustment on December 31 of the first year should be a. No Entry. b. Unearned rental income 2,500 Rental income 2,500 c. Rental income 2,500 Unearned rental income 2,500 d. Unearned rental income 12,500 Rental income 12,500

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9. After a successful drive aimed at members of a specific national association, Online Company received a total of P180,000 for 3-year subscriptions beginning April 1, 2006, and recorded this amount in the unearned revenue account. Assuming Online records adjustment only at the end of the calendar year, the adjusting entry required to reflect the proper balances in the accounts at December 31, 2006 is to a. Debit subscription revenue for P135,000 and credit unearned revenue for P135,000. b. Debit unearned revenue for P135,000 and credit subscription revenue for P135,000. c. Debit subscription revenue for P45,000 and credit unearned revenue for P45,000. d. Debit unearned revenue for P45,000 and credit subscription revenue for P45,000. 10. Jay Corporation renewed an insurance policy for 3-years beginning July 1, 2006 and recorded the P81,000 premium in the prepaid insurance accounts. The P81,000 premium represents an increase of P23,400 from the P57,600 premium charged 3 years ago. Assuming Jay'’ records its insurance adjustments only at the end of the calendar year, the adjusting entry required to reflect the proper balances in the insurance accounts at December 31, 2006, Jay’s year-end is to a. Debit insurance expense for P13,500 and credit prepaid insurance for P13,500. b. Debit prepaid insurance for P13,500 and credit insurance expense for P13,500. c. Debit insurance expense for P67,500 and credit prepaid insurance for P67,500. d. Debit insurance expense for P23,100 and credit prepaid insurance for P23,100. 11. The 2006 financial statements of Hershey Company reported net income for the year ended December 31, 2006 of 2 million. On July 1, 2007, subsequent to the issuance of the 2006 financial statements, Hershey changed from an accounting principle that is not generally accepted to one that is generally accepted. If the generally accepted accounting principle had been used in 2006, net income for the year ended December 31, 2006 would have been decreased by 1 million. On August 1, 2007, Hershey discovered a mathematical error relating to its 2006 financial statements. If this error had been discovered in 2006, net income for the year ended would have been increased by P500,000. What amount, if any, should be included in net income for the year ended December 31, 2007 because of the items noted above? a. P 0 c. P 500,000 increase b. P 500,000 decrease d. P 1,000,000 decrease 12. Edcelle Company reported a retained earnings balance of P400,000 at December 31, 2005. In August 2006, Edcelle determined that insurance premiums of P60,000 for the 3-year period beginning January 1, 2005 had been paid and fully expensed in 2005. Edcelle has a 30% income tax rate. What amount should Edcelle report as adjusted beginning retained earnings in its 2006 statement of retained earnings? a. P 442,000 b. P 440,000 c. P 428,000 d. P 420,000 13. Colasissi Corporation failed to accrue warranty costs of P50,000 in its December 31, 2005 financial statements. In addition, a change from straight-line to accelerated depreciation made at the beginning of 2006 resulted in a cumulative effect of P30,000 on Colasissi’s retained earnings. Both the P50,000 and P30,000 are net of related income taxes. What amount should Colasissi report as prior period adjustments in 2006? a. P 0 b. P 30,000 c. P 50,000 d. P 80,000

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Questions 14 and 15 are based on the following information. On October 1, 2006, Yuri Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Yuri recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, 2006. Yuri’s 2006 financial statements reported interest payable and interest expense on the note for 3 months at 16%. All amounts due on the note were paid February 1, 2007. 14. Yuri’s 2006 cost of goods sold for the holiday merchandise was a. Overstated by the difference between the note’s face amount and the note’s October 1, 2006 present value. b. Overstated by the difference between the note’s face amount and the note’s October 1, 2006 present value plus 11% interest for 2 months. c. Understated by the difference between the note’s face amount and the note’s October 1, 2006 present value. d. Understated by the difference between the note’s face amount and the note’s October 1, 2006 present value plus 11% interest for 2 months. 15. As a result of Yuri’s accounting treatment of the note, interest, and merchandise, which of the following items was reported correctly?

a. b. c. d.

12/31/06 Retained earnings Yes No Yes No

12/31/06 Interest payable Yes No No Yes

16. On December 31, 2006, Excel Corp. sold merchandise for P75,000 to Fineafle Co. The terms of the sale were net 30, FOB shipping point. The merchandise was shipped on December 31, 2006 and arrived at Fineafle on January 5, 2007. Because of a clerical error, the sale was not recorded until January 2007, and the merchandise, sold at 25% markup, was included in Excel’s inventory at December 31, 2006. As a result, Excel’s cost of goods sold for the year ended December 31, 2006 was a. Understated by P 75,000 c. Understated by P 15,000 b. Understated by P 60,000 d. Correctly stated 17. For the past 3 years, Greenwish Co. has failed to accrue unpaid wages earned by workers during the last week of the year. The amounts omitted, which are considered material, were as follows: December 31, 2003 December 31, 2005 December 31, 2006

P56,000 51,000 64,000

The entry on December 31, 2006 to correct for these omissions would include a a. Credit to wage expense for P64,000 b. Debit to wage expense for P51,000 c. Debit to wage expense for P13,000 d. Credit to retained earnings for P64,000

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18. An audit of Funny Co. for 2006, its first year of operations, detected the following errors made at December 31, 2006: Failed Failed Failed Failed

to to to to

accrue P50,000 interest expense record depreciation expense on office equipment of P80,000 amortize prepaid rent expense of P100,000 delay recognition of prepaid advertising expense of P60,000

The net effect of these errors was to overstate net income for 2006 by a. P 130,000 b. P 170,000 c. P 230,000 d. P 290,000 19. While preparing its 2006 financial statements, Falfact Corp. discovered computational errors in its 2005 and 2004 depreciation expense. These errors resulted in overstatement of each year’s income by P25,000, net of income taxes. The following amounts were reported in the previously issued financial statements: 2005 2004 Retained earnings, 1/1 P 700,000 P 500,000 Net income 150,000 200,000 Retained earnings, 12/31 P 850,000 P 700,000 Falfact’s 2006 net income is correctly reported at P180,000. Which of the following amounts should be reported as prior-period adjustments and net income in Falfact’s 2006 and 2005 comparative financial statements? Year a. 2005 2006 b. 2005 2006 c. 2005 2006 d. 2005 2006

Prior period adjustment P (50,000) (50,000) (25,000) -

Net income P150,000 180,000 150,000 180,000 125,000 180,000 125,000 180,000

20. The following information appeared on Blight Inc.’s December 31 financial statements: 2005 2006 Assets P 1,000,000 P1,200,000 Liabilities 750,000 800,000 Contributed capital 120,000 120,000 Dividends paid 100,000 60,000 In preparing its 2006 financial statements, Blight discovered that it had misplaced a decimal in calculating depreciation for 2005. This error overstated 2005 depreciation by P10,000. In addition, changing technology had significantly shortened the useful life of Blight’s computers. Based on this information, Blight determined that depreciation should be P30,000 higher in 2006 financial statements. Assuming that no correcting or adjusting entries have been made and ignoring income taxes, how much should Blight report as 2006 net income? a. P 230,000 b. P 210,000 c. P 180,000 d. P 170,000

5

Questions 21 and 22 are based on the following information. An audit of Angelina Company has revealed the following four errors that have occurred but have not been corrected:    

Inventory at December 31, 2005-P40,000, understated Inventory at December 31, 2006-P15,000, overstated Depreciation for 2005-P7,000, understated Accrued expenses at December 31, 2006-P10,000, understated

21. The errors cause the reported net income for the year ending December 31, 2006 to be a. Overstated by P72,000 c. Understated by P28,000 b. Overstated by P65,000 d. Understated by P45,000 22. The errors cause the reported retained earnings at December 31, 2006 to be a. Overstated by P65,000 c. Overstated by P25,000 b. Overstated by P32,000 d. Understated by P18,000 23. Collection of notes receivable of P50,000 plus interest of P500 was recorded as debit to cash of P50,500 and notes receivable of P50,500. This error will a. Overstate the expenses by P500 b. Understate the liability by P500 c. Understate assets by P500 and understate revenue by P500 d. Understate revenue by P500 24. Accounts payable of P32,000 was paid and erroneously recorded as debit to accounts payable and credit to cash for P23,000. The working capital a. Has no effect c. Is understated by P9,000 b. Is overstated by P9,000 d. Is understated by P23,000 25. The beginning accumulated depreciation per record was P100,000. During the year, the firm sold one of its machines recorded as follows: Cash 270,000 Accumulated depreciation - machine 30,000 Machine 300,000 If the actual cash proceeds is P300,000, the correcting entry would be: a. Cash 300,000 Machine 300,000 b. Cash 30,000 Gain on sale of machine 30,000 c. Accumulated depreciation - machine 30,000 Gain on sale of machine 30,000 d. Cash 300,000 Machine 270,000 Gain on sale of machine 30,000 26. Based on no. 25, assume that the nominal accounts had been closed. The effect of the error to the accounting elements, if not corrected, is a. P30,000 understatement of the net income. b. P30,000 understatement of asset and P30,000 understatement of net income. c. P30,000 understatement of asset and P30,000 understatement of owner’s equity. d. P30,000 understatement of asset and P30,000 overstatement of owner’s equity.

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27. A cash purchase of P5,200 was recorded as P2,500. The error had been discovered when nominal accounts were already closed to income summary, but not yet closed to the capital account. The correcting entry will require a a. P2,700 debit to accounts receivable b. P2,700 debit to purchases c. P2,700 credit to purchases d. P2,700 credit to accounts payable 28. Under the periodic inventory system, the ending inventory of P65,000 was erroneously recorded as P56,000. The error had been discovered when all nominal and temporary accounts were already closed to the real account. The correcting entry would require a a. Debit to capital account c. Credit to cost of sale b. Debit to income summary account d. Credit to owner’s capital 29. A sales discount of P5,000 was recorded as purchase discount. The error had been discovered when nominal accounts were still open. The correcting entry would require a a. P5,000 debit to purchase discount c. P5,000 credit to sales discount b. P5,000 credit to purchase discount d. P5,000 credit to accounts payable 30. An owner’s withdrawal amounting to P20,000 was erroneously recorded as salaries expense. The error had been discovered when all temporary accounts were already closed to the capital account. The correcting entry will require a a. P20,000 debit to owner’s capital c. P20,000 debit to salaries expense b. P20,000 debit to owner’s drawings d. No correcting entry is necessary 31. A payment of P20,000 rent was recorded as a debit to rent income. The error had been discovered when nominal accounts were already closed. The correcting entry would require a a. P20,000 debit to rent expense c. P40,000 credit to rent income b. P20,000 debit to rent income d. No adjustment entry is necessary 32.A cash collection of P5,000 from customer’s open account was recorded as P500. The error had been discovered when nominal accounts were still open. The correcting entry would require a a. P4,500 debit to accounts receivable c. P500 credit to accounts receivable b. P4,500 debit to cash d. P500 credit to cash 33. A sale of merchandise on account of P3,200 was recorded as P2,300. The error had been discovered when nominal accounts were already closed. The correcting would require a a. P900 debit to cash. c. P900 debit to sale b. P900 debit to accounts receivable d. P900 credit to accounts receivable 34. A collection of P5,000 notes receivable, plus P500 interest income was recorded as debit to cash P5,500 and credit to notes receivable P5,500. The error had been discovered when nominal accounts were still open. The correcting entry would require a a. P500 debit to cash. c. P500 credit to cash b. P500 debit to accounts receivable d. P500 credit to interest income

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35.The accrued interest on a 12%, 60-day note of a customer dated December 1, 2006 with a face value of P100,000 was not taken up as of December 31, 2004. The collection of the note, which matured on January 31, 2007, was recorded as Cash 102,000 Notes receivable 100,000 Interest Income 2,000 The error was discovered after collection. The correcting entry would require a a. P2,000 debit to cash. b. P2,000 debit to accrued interest receivable c. P1,000 debit to interest income d. P2,000 credit to interest income 36.A return of merchandise amounting to P4,500 which was previously purchased on account was recorded as Accounts payable Purchases

5,400 5,400

If the error had been discovered when the nominal accounts were still open, the correcting entry would require a a. P900 debit to purchase return b. P900 debit to accounts payable c. P900 credit to purchases d. P900 credit to accounts payable

Answer: 1. c 2. a

3, d

4, b

5. d

6. a

7. b

8. d

9. d

10. d

11. d

12. c

13. c

14. a

15. d

16. b

17. c

18. b

19. a

20. c

21. b

22. b

23. c

24. a

25. b

26. c

27. b

28. c

29. b

30. d

31. d

32. b

33. b

34. d

35. c

36. d

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Problem 1 The first audit of the books of Luzon Company was made for the year ended December 31, 2006. In examining the books, the auditor found that certain items had been overlooked or incorrectly handled in the last 3 years. These items are: a. At the beginning of 2004, the company purchased a machine for P1,020,000 (salvage value of P102,000) that had a useful life of 6 years. The bookkeeper used straight-line depreciation, but failed to deduct the salvage value in computing the depreciation base for the 3 years. b. At the end of 2005, the company failed to accrue sales salaries of P90,000. c. A tax lawsuit that involved the year 2004 was settled late in 2006. It was determined that the company owed an additional P170,000 in taxes related to 2004. The company did not record a liability in 2004 or 2005 because the possibility of loss was considered remote, and charged the P170,000 to a loss account in 2006. d. Luzon Company purchased another company early in 2004 and recorded goodwill of P900,000. Luzon had not amortized goodwill because its value had not diminished. The estimated economic life of the goodwill is 20 years. e. In 2006, the company wrote off P174,000 of inventory considered to be obsolete; this loss was charged directly to Retained Earnings. f.

Year-end wages payable of P6,800 were not recorded because the bookkeeper though that “they were immaterial.”

g. Insurance for a 12-month period purchased on November 1 of this year was charged to insurance expense in the amount of P5,280 because “the amount of the check is about the same every year. Questions 1. The entry to record the adjustment of item “a” is: a. Accumulated depreciation 34,000 Retained earnings Depreciation expense b. Accumulated depreciation 51,000 Retained earnings Depreciation expense c. Accumulated depreciation 17,000 Depreciation expense d. Accumulated depreciation 17,000 Retained earnings 2. The entry to record the adjustment of item “c”: a. No adjustment. b. Retained earnings 170,000 Estimated liability c. Loss on damages 170,000 Estimated liability d. Loss on damages 170,000 Cash

17,000 17,000 34,000 17,000 17,000 17,000

170,000 170,000 170,000

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3. Net income of 2005 is overstated by: a. P 460,400 b. P 318,400

c. P 107,000

d. P 73,000

4. Net income of 2006 is overstated by: a. P 367,000 b. P 312,000

c. P 103,400

d. P 69,400

Solution a. Accumulated depreciation 51,000 Depreciation expense (2006) Retained earnings (2004 & 2005) b. Retained earnings 90,000 Salaries expense c. No adjustment d. No adjustment since no indication of impairment. e. Loss on obsolete inventory 174,000 Retained earnings f. Salaries expense 6,800 Salaries payable g. Prepaid insurance 4,400 Insurance expense 2004 17,000

Item A Item B Item C Item D Item E Item F Item G Net Effect Answer: 1. B

-

___________ 17,000 2. A

3. D

17,000 34,000 90,000

174,000 6,800 4,400 2005 17,000 (90,000) -

2006 17,000 90,000 -

__________ (73,000

(174,000) (6,800) 4,400 (69,400)

4. D

Problem 2 A CPA is engaged by the Sony Corporation in 2006 to examine the books and records and to make whatever corrections are necessary. An examination of the accounts discloses the following: a. Dividends had been declared on December 15 in 2004 and 2005 but had not been entered in the books until paid. b. Improvements in building and equipment of P9,600 had been debited to expense at the end of April 2003. Improvements are estimated to have an 8-year life. The company uses the straight-line method in recording depreciation and computes depreciation to the nearest month. c. The physical inventory of merchandise had been understated by P3,000 at the end of 2004 and by P4,300 at the end of 2005. d. The merchandise inventories at the end of 2005 and 2006 did not include merchandise that was then in transit and to which the company had title. This shipments of P3,800 and P5,500 were recorded as purchases in January of 2006 and 2004, respectively. e. The company had failed to record sales commissions payable of P2,100 and P1,700 at the end of 2005 and 2006, respectively.

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f.

The company had failed to recognized supplies on hand of P1,200 and P2,500 at the end of 2005 and 2006, respectively.

The Retained Earnings account showed the following postings: 2004 2005

2006

Date Jan 1 Dec 31 Jan 10 Mar 6 Dec31 Jan 10 Dec 31

Item Balance Net income for year Dividends paid Stock sold – excess over par Net loss for year Dividend paid Net loss for year

Debit

Credit 81,000 18,000

15,000 32,000 11,200 15,000 12,400

Questions: 1. Corrected net income of 2004 a. P 19,800 b. P 15,600

c. P 13,600

d. P 16,800

2. Corrected net loss of 2005 a. P 16,000 b. P 14,000

c. P 12,000

d. P 10,000

3. Corrected net loss of 2006 a. P 16,200 b. P 15,800

c. P 15,200

d. P 12,800

4. Adjusted retained earnings at December 31, 2004 a. P 109,200 b. P 106,400 c. P 94,600

d. P 85,000

5. Adjusted retained earnings at December 31, 2005 a. P 71,200 b. P 69,000 c. P 67,600

d. P 65,000

6. Adjusted retained earnings at December 31, 2006 a. P 51,400 b. P 49,800 c. P 49,000

d. P 48,200

Solution Unadjusted Net income/Loss Item B Item C

2004 18,000 (1,200) 3,000

Item D – unrecorded ending inv. - unrecorded purchases

(3,800)

Item E Item F Adjusted net income/loss Retained earnings – beg. Item A Item B – error in recording improv. - unrecorded depreciation Retained earnings - end Answer: 1. A 2. C 3. A

2005 (11,200) (1,200) (3,000) 4,300 3,800

(2,100) ___________ 19,800 81,000 (15,000) 9,600 (800) 94,600 4. C

1,200 __________ (12,000) 94,600 (15,000) _________ 67,600 5. C

2006 (12,400) (1,200) (4,300) (3,800) 5,500 3,800 (5,500) 2,100 (1,700) (1,200) 2,500 (16,200) 67,600 ____________ 51,400 6. A

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Problem 3 A partial trial balance of Josh Alejandro Corporation is as follows on December 31, 2006: Dr.____ ____Cr.____ Supplies on hand P 13,500 Accrued salaries and wages P 7,500 Interest receivable on investments 25,500 Prepaid insurance 450,000 Unearned rent -0Accrued interest payable 75,000 Additional adjusting data: a. A physical count of supplies on hand on December 31, 2006, totaled P5,500. b. Through oversight, the Accrued Salaries and Wages account was not changed during 2006. Accrued salaries and wages on 12/31/06 amounted to P22,000. c. The interest receivable on investments account was also left unchanged during 2006. Accrued interest on investments amounts to P21,750 on 12/31/06. d. The unexpired portions of the insurance policies totaled P325,000 as of December 31, 2006. e. P140,000 was received on January 1, 2005, for the rent of a building for both 2005 and 2006. The entire amount was credited to rental income. f.

Depreciation for the year was erroneously recorded as P25,000 rather than the figure of P250,000.

correct

g. A further review of depreciation calculations of prior year revealed that depreciation of P36,000 was not recorded. It was decided that this oversight should be corrected by a prior period adjustment. Questions 1. The accrued salaries and wages at year-end is: a. P 29,500 b. P22,000 c. P 14,500

d. P 7,500

2. How much is the adjusted salaries and wages at year-end assuming that the balance of this account in the book is P350,000? a. P 379,500 b. P 372,000 c. P 364,500 d. P 342,500 3. Prepaid insurance at year-end is: a. P 450,000 b. P 325,000 4. Supplies on hand at year-end is: a. P 13,500 b. P 8,000 5. Depreciation expense at year-end is: a. Understated by P225,000 b. Overstated by P225,000 c. Understated by P261,000 d. Overstated by P261,000

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c. P 125,000

d. P 0

c. P 5,500

d. P 2,500

Solution 1. Supplies expense Supplies on hand 2. Accrued salaries and wages Salaries and wages expense To reverse accrued salaries. Salaries and wages expense Accrued salaries and wages 3. Interest income Interest receivable To reverse accrued income. Interest receivable Interest income 4. Insurance expense Prepaid insurance 5. Retained earnings Rent income 6. Depreciation expense Accumulated depreciation 7. Retained earnings Accumulated depreciation Answer: 1. B 2. C 3. B

8,000

8,000

7,500

7,500

22,000

22,000

25,500

25,500

21,750

21,750

125,000

125,000

70,000

70,000

225,000

225,000

36,000

36,000 4. C

5. A

Problem 4 The before tax income for Franzine Gomez Co. for 2005 was P303,000 and P232,200 for 2006. However, the accountant noted that the following errors had been made: 1. Sales for 2005 included amounts of P114,600 which was received in cash during 2005, but for which the related products were delivered in 2006. Title did not pass to the purchaser until 2006. 2. The inventory on December 31, 2005, was understated by P25,920. 3. The bookkeeper in recording interest expense for both 2005 and 2006 on bonds payable made the following entry: Interest expense Cash

15,000 15,000

The bonds have a face value of P250,000 and pay a stated interest rate of 6%. They were issued at a discount of P15,000 on January 1, 2005, to yield an effective interest of 7%. (Assume that the effective yield method should be used.) 4. Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2005 and 2006 for P25,500 and P30,000, respectively. The company applies a rate of 10% to the balance in the equipment account at the end of the year in its determination of depreciation charges. Questions 1. The adjusted 2005 net income is: a. P 422,120 b. P 419,120

c. P 192,920

d. P 189,920

2. The adjusted 2006 net income is: a. P 294,878 b. P 291,878

c. P 180,278

d. P 65,678

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3. 2005 net income is overstated by: a. P 232,200 b. P 229,200

c. P 113,080

4. 2006 net income is: a. Understated by P62,678 b. Understated by P59,678 c. Overstated by P166,522 d. Overstated by P51,922 5. The correcting entry in item “1” is: a. Accounts receivable Sales b. Sales Accounts receivable c. Retained earnings Sales d. Sales Retained earnings Solution 1. Retained earnings Sales 2. Cost of sales (beg. inv) Retained earnings 3. Retained earnings Interest expense Discount on bonds payable Int. paid 2002 2003 4.

114,600 114,600 114,600 114,600 114,600

114,600

25,920

25,920

1,450 1,552 Int. exp.

15,000 15,000

3,002 Carrying Value 235,000 1,450 236,450 1,552 238,002

Amort.

16,450 16,552 25,500 30,000

55,500

5,100

2,550 2,550

3,000

Unadjusted net income Item 1 Item 2 Item 3 Item 4 - error in recording depreciation

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114,600 114,600

114,600

Retained earnings Repairs expense Equipment Accumulated depreciation Retained earnings Depreciation expense Accumulated depreciation Depreciation expense

Adjusted net income Answer: 1. D 2. A

114,600

3. C

3,000

2002 303,000 (114,600) 25,920 (1,450) (25,500) 2,550 __________ 189,920 4. A

2003 232,200 114,600 (25,920) (1,552) (30,000 2,550 3,000 294,878 5. C

d. P

3,000

Problem 5 You have been assigned to examine the financial statements of Macelle Company for the year ended December 31, 2006. Below is the Balance Sheet of the company. Current assets Non-current assets Total Assets

700,000 2,000,000 _________ 2,700,000

Current liabilities Non-current liabilities Stockholders’ Equity Total liabilities/SHE

250,000 900,000 1,550,000 2,700,000

In the course of your audit, you discover the following situations: 1. Depreciation of P16,000 for 2006 on delivery vehicles was not recorded. 2. The physical inventory count on December 31, 2005, improperly excluded merchandise costing P95,000 that had been temporarily stored in a public warehouse. Macelle uses periodic inventory system. 3. The physical inventory count on December 31, 2006, improperly included merchandise with a cost of P42,500 that had been recorded as a sale on December 27, 2006. 4. A collection of P28,000 on account from a customer received on was not recorded until January 2, 2007.

December 31, 2006

5. In 2006, the company sold for P18,500 fully depreciated equipment that originally cost P110,000. The company credited the proceeds from the sale to the Equipment account. 6. During November 2006, a competitor company filed a patent-infringement suit against Macelle claiming damages of P1,100,000. The company’s legal counsel has indicated that an unfavorable verdict is probable and a reasonable estimate of the court’s award to the competitor is P625,000. The company has not reflected or disclosed this situation in the financial statements. 7. Macelle has a portfolio of trading securities. No entry has been made to adjust to market. Information on cost and market value is as follows: December 31, 2005 December 31, 2006

COST P 190,000 168,000

MARKET P 190,000 164,000

8. At December 31, 2006, an analysis of payroll information shows accrued salaries of P36,600. The Accrued Salaries payable account had a balance of P48,000 at December 31, 2006, which was unchanged from its balance at December 31, 2005. 9. A large piece of equipment was purchased on January 3, 2006, for P1,600,000 and was charged to Repairs Expense. The equipment is estimated to have a service life of 8 years and no residual value. Macelle normally uses the straight – line depreciation method for this type of equipment. 10. A P75,000 insurance premium paid on July 1, 2005, for a policy that expires on June 30, 2009, was charged to insurance expense. 11. A trademark was acquired at the beginning of 2005 for P250,000. No amortization has been recorded since its acquisition. Trademark has an economic life of 5 years.

15

Questions 1. Current assets at year-end is: a. P 776,000 b. P 695,000

c. P 691,000

d. P 678,500

2. Non-current assets at year-end is: a. P 3,498,500 b. P 3,402,500

c. P 3,302,500

d. P 3,298,500

3. Current liabilities at year-end is: a. P 911,600 b. P 863,600

c. P 286,600

d. P 238,600

4. Non-current liabilities at year-end is: a. P 1,561,600 b. P 1,525,000

c. P 1,513,600

d. P 900,000

5. The net income of 2006 is understated by: a. P 622,400 b. P 603,900

c. P 568,400

d. P 559,900

6. The total amount of fundamental error is: a. P 176,000 b. P 157,500

c. P 107,500

d. P 25,000

7. Total Stockholders’ Equity at year-end is: a. P 2,329,900 b. P 2,229,900

c. P 2,227,400

d. P 2,099,400

8. The correcting entry of item “3” assuming the company’s books were already closed is: a. No adjustment b. Retained earnings 42,500 Cost of sales 42,500 c. Cost of sales 42,500 Retained earnings 42,500 d. Retained Earnings 42,500 Inventory 42,500 Solution 1. Depreciation expense 16,000 Accumulated depreciation 2. Cost of sales (beg. inv) 95,000 Retained earnings 3. Cost of sales 42,500 Inventory 4. Cash 28,000 Accounts receivable 5. Accumulated depreciation 110,000 Machinery Gain on sale 6. Loss on damages 625,000 Estimated liability on damages 7. Unrealized holding loss 26,000 Valuation allowance Market value – beg. 190,000 Market value – end 164,000 Unrealized holding loss 26,000 8. Salaries payable 48,000 Salaries expense To reverse accrued salaries. Salaries expense 36,600 Salaries payable 9. Equipment 1,600,000 Repairs expense Depreciation expense 200,000 Accumulated depreciation

16

16,000 95,000 42,500 28,000 91,500 18,500 625,000 26,000

48,000 36,600 1,600,000 200,000

10. Insurance expense 25,000 Prepaid insurance 37,500 Retained earnings 11. No amortization since no information about its impairment. Answer: 1. C 2. B

3. B

4. D

5. B

6. A

7. A

62,500

8. D

Problem 6 Matias Corporation requires audited financial statements for credit purposes. After making normal adjusting entries, but before closing the accounting records for the year ended December 31, 2006. Matias’s controller prepared the following financial statements for 2006: Matias Corporation STATEMENT OF FINANCIAL POSITION December 31, 2006 Assets Cash 1,225,000 Marketable equity securities 125,000 Accounts Receivable 460,000 Allowance for doubtful accounts ( 55,000) Inventories 530,000 Property and equipment 620,000 Accumulated Depreciation ( 280,000) Total Assets 2,625,000 Liabilities and Stockholders’ Equity Accounts payable and accrued liabilities Income tax payable Common stock, P20 par Additional paid-in capital Retained earnings Total liabilities and stockholders’ equity

1,685,000 110,000 300,000 75,000 455,000 2,625,000

Matias Corporation STATEMENT OF INCOME For the Year Ended December 31, 2006 Net Sales 1,700,000 Cost of sales 570,000 Gross Profit 1,130,000 Operating Expenses Selling and administrative 448,000 Depreciation 42,000 Income before income tax 640,000 Income tax expense 192,000 Net Income 448,000 Matias’s tax rate for all items was 30% for all affected years, and it made estimated tax payments when due. Matias has been profitable in the past and expects results in the future to be similar to 2006. During the course of the audit, the following additional information (not considered when the above statements were prepared) was obtained: 1. The investment portfolio consists of short-term investment, classified as available-forsale, for which total market value equaled cost at December 31, 2005. On February 2,

17

2006, Matias sold one investment with a carrying value of P100,000 for P130,000. The total of the sale proceeds was credited to the investment account. 2. At December 31, 2006, the market value of the remaining securities in the portfolio was P142,000. 3. The P530,000 inventory total, which was based on a physical count at December 31, 2006, was priced at cost. Subsequently, it was determined that the inventory cost was overstated by P66,000. At December 31, 2006, the inventory’s market value approximated the adjusted cost. 4. Pollution control devices costing P48,000, which is high in relation to the cost of the original equipment, were installed on December 29, 2005, and were charged to repairs in 2005. 5. The original equipment referred to in Item 4, which had a remaining useful life of six years on December 20, 2005, is being depreciated by the straight-line method for both financial and tax reporting. 6. A lawsuit was filed against Matias Corporation in October 2006 claiming damages of P250,000. Company’s legal counsel believes that an unfavorable outcome is probable, and a reasonable estimate of the court’s award to the plaintiff is P60,000, which will be paid in 2007 if the case is settled. Questions 1. Marketable Equity Securities at year-end is: a. P 155,000 b. P 125,000

c. P 95,000

d. P 82,000

2. Allowance for market decline in value of marketable equity security at year-end is: a. P 0 b. P 8,000 c. P 10,000 d. P 13,000 3. Inventory at year-end is: a. P 464,000 b. P 512,000

c. P 530,000

d. P 596,000

4. Cost of sales at year-end is: a. P 636,000 b. P 570,000

c. P 550,000

d. P 504,000

5. Net income of the company is: a. P 399,700 b. P 379,000

c. P 366,100

d. P 331,000

Solution 1. Marketable equity securities Gain on sale 2. Loss on market decline Allowance for market decline 3. Cost of sales Inventory 4. Equipment Retained earnings 5. Depreciation Accumulated depreciation 6. Loss on damages Estimated liability on damages Answer: 1. A 2. D 3. A

18

30,000

30,000

13,000

13,000

66,000

66,000

48,000

48,000

8,000

8,000

60,000

60,000 4. A

5. C

Problem 7 Long established a retail business in 2004. Early in 2007, Long entered into negotiations with Short with the intent to form a partnership. You have been asked by Long and Short to check Long’s books for the past three years to help Short evaluate the earnings potential of the business. The net incomes reported on statements submitted to you were as follows:

Income, pretax

Year ending 12/31 2005 P 70,763

2004 P63,000

2006 P 61,880

During the examination of the accounts, you found the data given below: 2004

For year ended Dec. 31 2005 2006

Omission from the books a. Accrued expenses at end of year b. Earned (uncollected) revenue at end of year c. Prepaid expenses at end of year d. Unearned revenue (collected in advance) at end of year

P 15,120

P 14,658

P 32,368

1,400 6,314

8,470

9,842

4,270

Goods in transit at end of year omitted from inventory e. Purchase for which the entry had been made (ownership passed) f. Purchase for which the entry had not been made (ownership not passed)

18,270

21,640

11,970

13,710

Other points requiring considerations: g. On January 1, 2006, sold operational equipment for P31,500 that originally cost P35,000 on January 1, 2004. Cash was debited for P31,500 and equipment was credited for P31,500. The asset sold was depreciated in 2004 and 2005 but not on the 2006 on the basis of a 10-year life and no residual value. h. No allowance for bad debts has been set up. An analysis of accounts receivable as of December 31, 2006, indicates that the allowance account should have a balance of P14,000, of which P3,500 relates to 2004, P4,900 to 2005, and P5,600 to 2006. Questions 1. Adjusted net income of 2004 is: a. P 85,834 b. P 82,334

c. P 52,094

d. P 39,466

2. Adjusted net income of 2005 is: a. P 81,669 b. P 81,081

c. P 80,157

d. P 76,769

3. Adjusted net income of 2006 is: a. P 86,502 b. P 56,682

c. P 51,082

d. P 42,682

19

4. Inventory at year-end is understated by: a. P 3,370 b. P 7,930

c. P 21,640

5. Accrued expenses at year-end is: a. Overstated by P17,710 b. Understated by P32,368

c. Understated by P31,908 d. Understated by P17,710

d. P 35,350

Solution Unadjusted net income Item A

2004 63,000 (15,120)

2005 70,763 15,120 (14,658)

1,400 6,314

(1,400) (6,314) 8,470

Item B Item C Item D Item E Item F Item G Item H Adjusted net income Answer: 1. C 2. B

(4,270) 18,270 -

-

(3,500) 52,094

(4,900) 81,081

3. C

4. C

2006 61,880 14,658 (32,368) (8,470) 9,842 4,270 (18,270) 21,640 3,500 (5,600) 51,082 5. B

Problem 8 VILLA LYDIA CO. The records of the Company have not been examined for the three-year period ended December 31, 2006. As a result of your audit of the records for the year ended December 31, 2006 and your review of the records of the two prior years, it is necessary to revise the net income and the retained income based upon the audited data, which follows: The company’s retained income at December 31, 2006 follows: Balance, 12/31/04 Net income, 2005 Net income, 2006 Balance, 12/31/06

P 90,000 100,000 110,000 P300,000

From your examination, you obtained the following information which must be taken into consideration at the close of the year involved: December 31, 2004 1. Goods consigned out to consignees are included in the inventory at P120,000, which is 20 percent in excess of cost. 2. Equipment with a 10-year-life was purchased for P30,000 and charged to expense on December 31. 3. The following liabilities are omitted from the records: Materials included in inventory P 3,000 Accrued taxes 4,100

20

December 31, 2005 4. Uncollectible accounts receivable of P9,000 are to be written off. 5. Marketable Securities costing P15,000 were at a market value of only P9,000. 6. Gain of P3,000 on sale of fully depreciated equipment was credited to the allowance for depreciation. 7. Land cost of P9,000 had been erroneously charged to expense. 8. The inventory is overstated by P14,300 because of an error in footing an inventory price sheet. 9. Depreciation was omitted; P5,000 should be provided. December 31, 2006 10. The following liabilities are omitted from the records: For purchases of new machinery on December 31, 2006 Accrued taxes

P12,000 5,900

Questions 1. Adjusted net income of 2005 is: a. P 119,400 b. P 110,800

c. P 102,600

d. P 90,800

2. Adjusted net income of 2006 is: a. P 89,800 b. P 98,600

c. P 115,400

d. P 145,400

3. Adjusted retained earnings of 2004 is: a. P 112,900 b. P 109,900

c. P 92,900

d. P 89,900

4. Adjusted retained earnings of 2005 is: a. P 180,700 b. P 203,700

c. P 212,500

d. P 212,300

5. Adjusted retained earnings of 2006 is: a. P 416,200 b. P 416,000

c. P 319,100

d. P 296,100

6

The entry to correct information “number 3” at December 31, 2006 is: a. Retained earnings 4,100 Accrued taxes 4,100 b. Cost of sales 3,000 Accounts payable 3,000 c. Retained earnings 4,100 Cost of sales 3,000 Accrued taxes 4,100 Accounts payable 3,000 d. No adjusting entry is necessary.

9. The entry to correct information “number 4” at December 31, 2006 is: a. Allowance for bad debts 9,000 Accounts receivable 9,000 b. Retained earnings 9,000 Accounts receivable 9,000 c. Retained earnings 9,000 Allowance for bad debts 9,000 d. No adjusting entry is necessary

21

8. Adjusted net income of 2004 (assuming P85,000 is recorded as net income of 2004) is: a. P 116,900 b. P 115,000 c. P 107,900 d. P 87,900 Solution 1. No adjustment since the 2004 financial statement was not affected. 2. Equipment 30,000 Retained earnings 30,000 Retained earnings 3,000 Depreciation expense 3,000 Accumulated depreciation 6,000 3. No adjustment since the 2004 financial statement was not affected. 4. Allowance for bad debts 9,000 Accounts receivable 9,000 5. Retained earnings 6,000 Allowance for market decline 6,000 6. Accumulated depreciation 3,000 Retained earnings 3,000 7. Land 9,000 Retained earnings 9,000 8. Retained earnings 14,300 Cost of sales 14,300 9. Retained earnings 5,000 Accumulated depreciation 5,000 10. Machinery 12,000 Accounts payable – others 12,000 Taxes 5,900 Accrued taxes 5,900 Unadjusted net income Item 1 Item 2 Item 3 Item 4 Item 5 Item 6 Item 7 Item 8 Item 9 Item 10 Adjusted net income Retained earnings - beg Adjustments: Item 1 Item 2 Item 3 Retained earnings - end Answer: 1. B 2. C 3. C 4. B

2004 (20,000) 30,000 (3,000) (4,100) -

_________

2005 100,000 20,000 (3,000) 3,000 4,100 (6,000) 3,000 9,000 (14,300) (5,000) _________ 110,800 90,000 (20,000) 30,000 (3,000) (4,100) 203,700

5. C

6. D

7. A

2006 110,000 (3,000) -

14,300 (5,900) 115,400 203,700

_________ 319,100

8. D

Problem 9 The Corporation prepared its own income statement for the years 2005 and 2006. The President was not satisfied and decided to engage the services of a CPA. The following errors were discovered by the CPA: ___2005__ ___2006___ Net income after income tax P 123,250 P 156,250 Inventory understatement at year-end P P 12,500 Prepaid expenses not taken up 5,000 15,000 Merchandise purchased on account not Recorded as liability but included in

22

inventory Unearned rent received taken into income Accrued taxes unrecorded

25,000 20,000

9,000 15,000

Questions 1. Net income of 2005 is: a. P 163,250

b. P 108,250 c. P 83,250

d. P 73,250

2. Net income of 2006 is: a. P 199,750

b. P 174,750 c. P 144,750

d. P 142,250

Solution Unadjusted net income

2005 123,250 5,000 (25,000)

Adjusted net income Answer: 1. C 2. A

(20,000) __________ 83,250

2006 156,250 12,500 (5,000) 15,000 25,000 (9,000) 20,000 (15,000) 199,750

Problem 1O Wizard Company, a calendar-year sole proprietorship, maintained its books on the cash basis during the year Wizard is in the process of negotiating a bank loan to finance the planned expansion of its business. The bank is requesting 2006 financial statements prepared on the accrual basis of accounting from Wizard. As Wizard’s external auditor, you were called upon to assist in preparing the financial statements. The following information were obtained during the course of your engagement: Wizard Company TRIAL BALANCE December 31, 2006 Debits Credits Cash P448,000 Accounts receivable, 12/31/05 283,500 Inventory, 12/31/05 1,085,000 Furniture & Fixtures 2,068,500 Leasehold improvements 787,500 Accumulated depreciation, 12/31/05 P 567,000 Accounts payable 297,500 Wizard, Drawings Wizard, Capital, 12/31/05 2,180,500 Sales 11,427,500 Purchases 5,339,250 Salaries expense 3,045,000 Taxes and licenses 217,000 Insurance expense 152,250 Rent expense 598,500 Utilities expense 220,500 Living expenses 227,500 _________ P 14,472,500 P 14,472,500

23

Additional information: 1. At December 31, 2006, amounts due from customers totaled P415,000. 2. Based on the analysis of the above receivables, P20,750 may prove uncollectible. 3. Unpaid invoices for the plant purchases totaled P533,750 and P297,500 at December 31, 2006 and December 31, 2005 respectively. 4. The inventory totaled P1,274,000 based on a physical count of the goods at December 31, 2006. The inventory was priced at cost, which approximates market value. 5. On May 1. 2006, Wizard paid P152,250 to renew its comprehensive insurance coverage for one year. The premium on the previous policy, which expired on April 30, 2006, was P136,500. 6. On January 2, 2006, Wizard entered into a twenty-year operating lease for the vacant lot adjacent Wizard’s retail store used as a parking lot. As agreed in the lease, Wizard paved and fenced in the lot at a cost of P787,500. The improvements were completed on April 1, 2006, and estimated to have a useful life of fifteen years. No provision for depreciation has been recorded. Depreciation on furniture and fixtures was P210,000 for 2006. 7. Accrued expenses at December 31, 2006 and 2005 were as follows: 2006 2005 Taxes and licenses P33,750 P20,250 Utilities 36,000 24,750 P69,750 P45,000 8. Wizard is being sued for P4,000,000. The coverage under the comprehensive insurance policy is limited to P2,500,000. Wizard’s attorney believes that an unfavorable outcome is probable and that a reasonable estimate of the settlement is P3,000,000. 9. The salaries account includes P40,000 per month paid to the proprietor. Wizard also receives P4,375 per week for living expenses. Questions Determine the balances of the following under the accrual basis of accounting. 1. Accounts Receivable a. 415,000

b. P 283,500

c. P 131,500

d. P 152,000

2. Accounts Receivable, net a. P 408,425 b. P 404,625

c. P 394,250

d. P 262,500

3. Inventory a. P 1,274,000

b. P 1,085,000

c. P 189,000

d. P 896,000

4. Prepaid Insurance a. P 147,000

b. P

c. P 50,750

d. P0

c. P 2,039,625

d. P 1,858,500

96,250

5. Property and equipment, net a. P 2,856,000 b. P 2,616,469

24

6. Accounts payable a. P 533,750

b. P 523,750

c. P 297,500

d.P 236,250

7. Accrued Expenses a. P 114,750

b. P

c. P 24,750

d. P0

8. Wizard, Drawings a. P 707,500

b. P 480,000

c.

d. P0

69,750

P 227,500

9. Wizard, Capital, 12/31/05 a. P 2,226,000 b. P 2,181,000

c. P 2,180,500

d. P 2,135,500

10. Sales a. P 11,842,500

b.

c. P 11,427,500

d. P 11,296,000

11. Purchases a. P 5,873,000

b. P 5,575,500

c. P 5,339,250

d. P 5,103,000

12. Salaries Expense a. P 3,272,500

b. P 3,045,000

c. P 2,655,000

d. P 2,565,000

13. Taxes and licenses a. P 250,750

b. P 230,500

c. P 217,000

d. P 203,500

14. Insurance expense a. P 197,750

b. P 147,000

c. P 152,250

d. P 101,500

15. Utilities expense a. P 256,500

b. P 231,750

c. P 220,500

d. P 195,750

16. Doubtful account expense a. P 20,750 b. P 10,375

c. P 6,575

d. P 0

17. Depreciation expense a. P 294,375

b. P 249,375

c. P 239,531

d. P 210,000

18. Cost of sales a. P 5,386,500

b. P 5,368,500

c. P 5,150,250

d. P 4,065,000

c. P 500,000

d. P0

P 11,559,000

19. Estimated loss from lawsuit a. P 4,000,000 b. P 3,000,000 Solution 1. A - P415,000 given in item no. 1 2. C - P394,250 (P415,000 – P20,750 item no. 2) 3. A - P1,274,000 given in item no. 4 4. C - P152,250 x 4/12 = P50,750 5. C Furniture & fixtures 2,068,500 Leasehold improvements 787,500 Less: Accumulated dep’n – 1/1/02 ( 567,000) 2002 Depreciation – improve. ( 39,375) 2002 Dep’n – furniture ( 210,000) Carrying value – 2002 2,039,625 6. A - P533,750 given in item no. 3 7. B - P69,750 given in item no. 7

25

8.

A

9.

B

10. B

11. B

12. D

13. B

14. B

15. B

16. 17. 18.

19.

Salaries – P40,000 x 12 Living allowance P4,375 x 52 weeks Total

- P 480,000 - 227,500 707,500

Capital – beg. Omission of prepaid expense in 2001 Omission of accrued expenses in 2001 Total

2,180,500 45,500 ( 45,000) 2,181,000

Sales – cash basis + AR – end - AR – beg Sales – accrual basis

- 11,427,500 415,000 283,500 - 11,559,000

Purchases – cash basis + AP – end - AP – beg Purchases – accrual basis

- 5,339,250 533,750 297,500 - 5,575,500

Salaries per record - 3,045,000 - Salaries of the proprietor * 480,000 Adjusted Salaries - 2,565,000 * Salaries of the proprietor for a partnership is considered as part of profit distribution Taxes and + Accrued - Accrued Taxes and

licenses – cash basis taxes – end taxes – beg licenses – accrual basis

- 217,000 - 33,750 - 20,250 - 230,500

Insurance expense – cash basis + Prepaid insurance – beg - Prepaid insurance – end Insurance expense – accrual basis

- 152,250 - 45,500 - 50,750 - 147,000

Utilities – cash basis + Accrued utilities – end - Accrued utilities – beg Utilities – accrual basis A – given in item # 2 B – refer to Question # 5 question A Beginning inventory Purchases Ending inventory Cost of Sales C Since there is a comprehensive insurance policy 2.5M)

- 220,500 - 36,000 - 24,750 - 231,750

-

1,085,000 5,575,500 (1,274,000) 5,386,500

for the damage, only P500,000 will be charged as loss (3M –

Problem 11 You have been engaged to examine the financial statements of Vince Corporation for the year ended December 31, 2006. In the course of your examination, you have ascertained the following information: 1. Vince uses the allowance method of accounting for uncollectible trade accounts receivable. The allowance is based upon 3% of past due accounts (over 120 days) and 1% of current accounts as of the close of each month. Due to the changing economic conditions and climate, the amount of past due accounts has increased significantly, and management has decided to increase the percentage based on past due accounts to 5%. The following balances are available:

26

Accounts Receivable Past due accounts (included in Accounts Receivable) Allowance for uncollectible accounts

As of Nov. 30, 2006

As of Dec. 31, 2006

Debit

Debit

Credit

Credit

P 390,000

-

P 430,000

-

12,000

-

30,000

-

-

P 28,000

9,000

-

2. The merchandise inventory on December 31, 2005 did not include merchandise having a cost of P7,000.00 which was stored in a public warehouse. Merchandise having a cost of P3,000.00 was erroneously counted twice and included twice in the merchandise inventory on December 31, 2006. Vince uses a periodic inventory system. 3. On January 2, 2006, Vince had a new machine delivered and installed in its new factory. The cost of this machine was P97,000.00 and the machine is being depreciated on a straight-line method over an estimated useful life of 10 years. When the new machine was installed, Vince paid for the following items which were not included in the cost of the machine, but were charged to repairs and maintenance: Delivery Expense P 2,500.00 Installation Costs 8,000.00 Rearrangement of related Equipment 4,000.00 P14,500.00 4. On May 3, 2006, Vince exchanged 500 shares of treasury stock (P50.00 par value common stock) for a parcel of land to be used as a site for a new factory. The treasury stock had a cost P70.00 per share when it was acquired and on May 03, 2006, it had a fair value of P80.00 per share. Vince received P2,000.00 when an existing building on the land was sold for scrap. The land was capitalized at P40,0000.00 and Vince recorded a gain of P5,000.00 on the sale of its treasury stock. You found the following journal entries Land . . . . . . . . . . . . . . Treasury stock . . . . . . . . Gain on Sale of treasury stock

in the books: . P 40,000.00 . . . . . . P 35,000.00 . . . . . 5,000.00

Cash . . . . . . . . . . . . . . . Miscellaneous Income . . . . . . . . . .

P

2,000.00 P 2,000.00

5. On January 02, 2006, Vince Corporation established a noncontributory defined benefit plan covering all employees and contributed P 1,000,000.00 to the plan and charged this amount to the “pension expense”. At December 31, 2006, Vince determined that the 2006 current service and interest costs on the plan amount to P 620,000,00. The expected and actual rate of return on plan assets for 2006 was 10%. Questions 1. The allowance for uncollectible accounts to be reported on the Balance Sheet is: a. P 14,500.00 b. P 9,000.00 c. P 5,500.00 d. P 4,000.00 2. Doubtful account expense at December 31, 2006 is: a. P 14,500.00 b. P 9,000.00 c. P 5,500.00

d. P 4,000.00

27

3. 2006 merchandise inventory is: a. Understated by P 10,000.00 b. Understated by P 4,000.00

c. Overstated by P 3,000.00 d. Overstated by P 4,000.00

4. If no proper correcting entries were made at December 31, 2005, by how much will 2005 net income before income taxes be overstated or understated? a. Understated by P7,000.00 c. Overstated by P 7,000.00 b. Understated by P4,000.00 d. Overstated by P 4,000.00 5. Machinery and equipment account should be reported in the balance sheet (net of accumulated depreciation) at December 31, 2006: a. P 100,350.00 b. P 110,050.00 c. P 111,500.00 d. P 101,800.00 6. Land account should be reported in the balance sheet at December 31, 2006: a. P 35,000.00 b. P 33,000.00 c. P 40,000.00 d. P 38,000.00 7. What should be reported at December 31, 2006 as prepaid pension cost? a. P 620,000.00 b. P 520,000.00 c. P 1,000,000.00 d. P 480,000.00 8. What amount should be reported as pension expense in 2006? a. P 620,000.00 b. P 520,000.00 c. P 1,000,000.00

d. P 480,000.00

9. How much gain should be reported on item no. 4? a. P 5,000.00 b. P 15,000.00 c. P 10,000.00

d. P 0

10. If no proper correcting entries were made at December 31, 2006, by how much will 2006 net income before income taxes be overstated or understated? a. Understated by P 493,450.00 c. Overstated by P 539,050.00 b. Understated by P 534,050.00 d. Overstated by P 498,450.00 Solution (1) Doubtful Account Expense 14,500.00 Allowance for D/A 14,500.00 Required allowance as of 12.31.2006 -on past due accounts (5% x P30,000.00) P 1,500.00 -on current accounts (1% x P400,000.00) 4,000.00 Total P 5,500.00 Unadjusted “debit” balance of Allowance for D/A 9,000.00 Additional Provision (expense) P14,500.00 (2) a. Merchandise Inventory, 01.01.2006 7,000.00 Retained Earnings 7,000.00 (to correct understatement of inventory at end of 2005) b. Cost of Sales 3,000.00 Merchandise Inventory, 12.31.2006 3,000.00 (to correct overstatement ending inventory for 2006) (3) a. Machinery 14,500.00 Repairs and Maintenance 14,500.00 (to reclassify delivery and installation costs) b. Depreciation Expense 1,450.00 Accumulated Depreciation 1,450.00 (to provide for depreciation for items not capitalized) (4) Miscellaneous Income 2,000.00 Gain on Sale of Treasury Stock 5,000.00 Land 2,000.00 APIC-T/S 5,000.00 (to correct client’s entry on the purchase of land) (5) Prepaid Pension Cost 480,000.00 Pension Expense 480,000.00 (to correct client’s entry in the treatment of prepaid pension cost)

28

Answer: 1. C 2. A

Current Service and interest cost Expected return on Plan Asset (P 1,000,000.00 x 10%) Pension Expense Reported pension expense Prepaid Pension Cost 3. C

4. A

5. A

6. D

P P

7. D

620,000.00 ( 100,000.00)_ 520,000.00 1,000,000.00 P 480,000.00

8. B

9. D

10. D

Problem 12 Ron-Ron Storage underwent a restructuring in 2006. The company conducted a thorough internal audit, during which the following facts were discovered. The audit occurred during 2006 before any adjusting entries or closing entries are prepared. a. Additional printers were acquired at the beginning of 2004 and added to the company’s office network. The P9,000 cost of the printers was inadvertently recorded as maintenance expense. The printers have five-year useful lives and no material salvage value. This class of equipment is depreciated by the straight-line method. b. Three weeks prior to the audit, the company paid P51,000 for storage boxes and recorded the expenditure as office supplies on hand. The error was discovered a week later. c. On December 31, 2005, inventory was understated by P112,000 due to a mistake in the physical inventory count. The company uses the periodic inventory system. d. Three years earlier, the company recorded a 3% stock dividend (4,000 common shares, P1) as follows: Retained earnings Common stock

4,000 4,000

The shares had a market price at the time of P10 per share. e. At the end of 2005, the company failed to accrue interest expense that accrued during the last four months of 2005 on bonds payable. The bonds which were issued at face value mature in 2010. The following entry was recorded on March 1, 2006, when the semi-annual interest was paid: Interest expense Cash f.

180,000 180,000

A three-year liability insurance policy was purchased at the beginning of 2005 for P216,000. The full premium was debited to insurance expense at the time.

Questions 1. Net income of 2004 is: a. Overstated by P9,000 b. Understated by P9,000

c. Overstated by P7,200 d. Understated by P7,200

2. Net income of 2005 is a. Understated by P374,200 b. Understated by P134,200

c. Understated by P89,800 d. Overstated by P81,800

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3. Net income of 2006 is a. Overstated by P65,800 b. Overstated by P185,800

c. Overstated by P305,800 d. Understated by P38,200

4. Accrued interest on Bonds Payable is a. P 60,000 b. P 80,000

c. P 120,000

Solution

2004 9,000 (1,800)

A B C D E F Under/(Over) Answer: 1. D 2. B 3. B

_________ 7,200

2005

d. P 180,000 2006

(1,800)

(1,800)

112,000

(112,000)

(120,000)

120,000 (120,000) (72,000) 185,800

144,000 134,200

4. C

Problem 13 You been asked by a client to review the records of the Claire Joy Company, a small manufacturer of precision tools and machines. Your client is interested in buying the business, and arrangements have been made for you to review the accounting records. Your examination reveals the following: a. Claire Joy Company commenced business on April 1, 2003, reporting on a fiscal year ending March 31. The company has never been audited, but the annual statements prepared by the bookkeeper reflect the following income before closing and before deducting income taxes: Year Ended March 31 2004……………………………………… 2005……………………………………… 2006………………………………………

Income Before Taxes P 71,600 111,400 103,580

b. A relatively small number of machines have been shipped on consignment. These transactions have been recorded as an ordinary sale and billed as such. On March 31 of each year, machines billed and in the hands of consignees amounted for: 2004…………………………………….. P7, 800 2005…………………………………….. none 2006…………………………………….. 5, 590 Sales price was determined by adding 30% to cost. goods were sold the following year.

You learned that the consigned

c. On March 30, 2005, two machines were shipped to a customer on a C.O.D. basis. The sale was not entered until April 5, 2005 when cash was received for P6,100. The machines were not included in the inventory at March 31, 2005. (Title passed on March 30, 2005). d. All machines are sold subject to a five-year warranty. It is estimated that the expense ultimately to be in connection with the warranty will amount to ½ of 1% of sales. The company has charged an expense account for warranty costs incurred.

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Sales per books and warranty costs were: Year Ended March 31 Sales 2004 P940, 000 2005 1, 010, 000 2006 1, 795, 000

Warranty of Expense for Sales 2004 2005 2006 P760 360 P1, 310 320 1, 620 P1, 910

Made in Total P760 1, 670 3, 850

e. The bank deducts 6% on all contracts financed. Of this amount ½% is place in a reserve to the credit of Claire Joy Company, which is refunded to Claire Joy as finance contracts are paid in full. The reserve established by the bank has not been reflected in the books of Claire Joy. The excess of credits over debits (net increase) to the reserve account with Claire Joy, on the books of the bank for each fiscal year were as follows: 2004…………………………………. P 4, 000 2005…………………………………. 4, 000 2006…………………………………. 5, 000 P 14, 000 f.

A delivery equipment with a 10-year life (no residual value, straight-line depreciation) was purchased on April 1, 2005 by issuing a P 600,000 non- interest- bearing, 4 year note. The entry made to record the purchase was a debit to Delivery Equipment and a credit to Notes payable for P 600,000; a 10% is a fair rate of interest on the note. The accountant failed to provide for depreciation for the year on this equipment.

g. For the last three (3) years, the company has failed to accrue salaries and wages. The correct amounts at the end of each fiscal year were: 2004…………………………………. P 12, 000 2005…………………………………. 18, 000 2006…………………………………. 10, 000 Questions Answer the following questions based on the audit findings. Ignore income tax implications. 1. The adjusting entry to set up the estimated Liability under Warranties is a. Warranty expense 5,411 Retained earnings 7,006 Estimated liability under warranties 12,417 b. Retained earnings 5,411 Warranty expense 7,006 Estimated liability under warranties 12,417 c. Warranty expense 12,417 Estimated liability under warranties 12,417 d. Retained earnings 12,417 Estimated liability under warranties 12,417 2. The total receivable from the bank representing dealers fund reserve as of March 31, 2006 is: a. P 5,100 b. P 6,900 c. P 12,000 d. P 14,000 3. Sales in 2004 were (over) understated by a. P 6,500 b. P (6,500)

c. P 7,800

d. P (7,800)

4. Sales in 2006 were (over) understated by: a. P 6,500 b. P (6,100)

c. P (5,590)

d. P (11,690)

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5. The accrued Salaries Payable that should be set up on March 31, 2006 is: a. P 18,000 b. P 28,000 c. P 10,000 d. P 40,000 6. The audited balance of Discount on Note Payable as of March 31, 2006 is: a. P 0 b. P 102, 452 c. P 149, 211 d. P 190, 192 7. Depreciation Expense for fiscal year 2006 that should be provided on the equipment purchased on April 1, 2005 is a. P 13,660 b. P 40,981 c. P 60,000 d. P 66,000 Solution Adjusting entry: b.

c. d.

e. f.

g.

Sales 5,590 Accounts receivable Inventory 4,300 Cost of sales Sales 6,100 Retained earnings - beg Warranty expense 12,417 Estimated warranty payable 2004 940,000 – 7,800 2005 1,010,000 + 6,100 – 7,800 2006 1,795,000 – 5,590 – 6,100 Adjusted balance X ½ of 1% Total Warranty expense Less: Warranty paid Estimated warranty liability Fund reserve from the bank 14,000 Other income OE: Delivery equipment 600,000 Notes payable CE: Delivery equipment 409,808 Discount on NP 190,192 Notes payable Adj: Discount on NP 190,192 Delivery equipment Adj: Interest expense 40,981 Discount on NP P409,808 x 10% = P 40,981 Retained earnings 18,000 Salaries Salaries 10,000 Accrued salaries

Answer: 1. C 2. D

3. D

4. D

5. C

6. C

5,590 4,300 6,100 12,417 = 932,200 = 1,023,900 = 1,783,310 = 3,739,410 = .005 = 18,697 = 6,280 = 12,417 14,000 600,000 600,000 190,192 40,981 18,000 10,000 7. B

Problem 14 You are auditing the accounts of Keith Zandro Merchandising Corporation for the year ended December 31, 2006. You discover that the adjustments made in the previous audit for the year 2005 were not entered in the accounts by Keith Zandro’s bookkeeper; therefore, the accounts are not in agreement with the audited amounts as of December 31, 2005. The following adjustments were included in the 2005 audit report: a. Invoices for merchandise purchased on credit in December 2005 were not entered on the books until payment of P12,000 was made in January 2006. The merchandise was not included in the December 31, 2005 inventory. The company uses a periodic inventory system.

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b. Invoices for merchandise received on credit in December 2005 were not recorded in the accounts until payment was made in January 2006; the goods were included in the 2005 ending inventory, P18,000. c. Allowance for doubtful accounts for 2005 was understated by P2,000 because bad debts expense in 2005 was not recorded. d. Selling expense for 2005, P5,000, was not recorded in the accounts until paid in 2006. e. Accrued wages of P4,000 at December 31, 2005, were not recorded in the accounts until paid in January 2006. f.

Prepaid insurance at December 31, 2005 was understated by P600 because this amount was included in 2005 expense. The insurance policy expires on December 31, 2006.

g. Income tax expense of P2,400 for the last part of the year ended December 31, 2005, was not recorded until paid in January 2006. h. Depreciation of P9,000 was not recorded for 2005. Questions: Based on the information given, answer the following: 1. Net income of 2005 is overstated by a. P 40,400 b. P 39,800

c. P 38,400

d. P 29,400

2. Net income of 2006 is understated by a. P 40,800 b. P 39,800

c. P 28,800

d. P 27,800

3. Operating expenses of 2005 is understated by a. P 21,800 b. P 21,800 c. P 20,600

d. P 19,400

4. Operating expense of 2006 is overstated by a. P 21,800 b. P 10,800

c. P 9,000

d. P 8,400

5. Cost of sales of 2006 is a. Overstated by P18,000 b. Understated by P18,000

c. Understated by P6,000 d. Not affected with error

Solution A. Omission of purchases Omission of inventory B. Omission of purchases C. D E F G H

NET INCOME 2005 2006 (12,000) 12,000 12,000 (12,000) (18,000) 18,000 (2,000) (5,000) 5,000 (4,000) 4,000 600 (600) (2,400) 2,400 (9,000) _______ (39,800) 28,800

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OPERATING EXPENSES 2005 2006

A B. C. D E F G H Answer: 1. B 2. C

3. D

4. D

(2,000) (5,000) (4,000) 600

5,000 4,000 (600)

(9,000) (19,400)

_______ 8,400

5. A

Pro0blem 15 Tuburan Company was organized during 2002 by three technical experts to assemble (parts to be purchased from suppliers) and market an electronic device that they had previously patented. No products were sold during 2002; however, 2003 and 2004 produced significant sales, but modest profits. During 2003, the company hired bookkeeper who, although very industrious, had very little knowledge of accounting. Realizing this competency problem, the company is considering engaging an outside independent CPA to as they said “straighten things out and make recommendations.” Among numerous other accounting problems, adjusting entries have never been made. The bookkeeper stated that “the transactions are recorded in the right way when they occur.” The following 2005 transactions, and the way in which the bookkeeper recorded or explained them, are being discussed: a. Inventory – ending 2004, P30,000; ending 2005, P47,000 (by inventory count). Inventory of parts 17,000 Purchases 17,000 b. Depreciation – equipment (purchased at the beginning of 2004) cost, P80,000; estimated useful life, 10 years; manufacturer’s recommended value at end of 5 years, P10,000. Depreciation expense 7,000 Equipment 7,000 c. Unpaid wages at year-end 2004, P3,000; 2005, P11,000. Record when paid, because that is when the wages requires the payment of resources and “it all events out anyway.” d. Note payable, P60,000, five-year, 15%, interest payable each October 31; signed November 1, 2004. Interest expense 9,000 Cash 9,000 Because this is the correct amount of interest each year e. Contract to deliver six electronic devices, signed October 15, 2005, pending assembly, P45,000. Due from customers 45,000 Sales 45,000 f.

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Property taxes for 2005, billed in November 2005, payable without penalty up to February 15, 2004, P9,000. Paid on February 14, 2006.

February 14, 2006: Property taxes Cash

9,000 9,000

g. Advertising costs for December 2005, Christmas season, P17,000. Paid, within the 30day credit period, on January 26, 2006. January 26, 2006: Advertising Cash

17,000 17,000

Questions: Based on the information given, answer the following: 1. Interest expense of the P60,000 note at December 31, 2005 is a. P 10,500 b. P 9,000 c. P 7,500

d. P 1,500

2. Interest payable at December 31, 2005 is a. P 9,000 b. P 7,500

c. P 1,500

d. P

3. Inventory at December 31, 2005 is a. P 64,000 b. P 47,000

c. P 30,000 d. Cannot be determined

4. Wages expense at December 31, 2005 is a. Understated by P 14,000 b. Understated by P 11,000

c. Understated by P 8,000 d. Correctly stated

5. Accrued expenses at December 31, 2005 is understated by a. P 38,500 b. P 12,500 c. P 11,750

750

d. P 11,000

Solution 1. B P 60,000 x 15% = P 9,000 2. C P 60,000 x 15% x 2/12 = P 1,500 3. B Given in item A 4. C Retained earnings 3,000 Wages expense 3,000 Wages expense 11,000 Wages payable 11,000 5. A Interest payable 1,500 Wages payable 11,000 Property taxes 9,000 Advertising 17,000 Total 38,500

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Problem 16 Branzuela Corporation reported the following amounts of net income for the years ended December 31, 2003, 2004 and 2005: 2003 2004 2005

P127,000 150,000 128,500

You are performing the audit for the year ended December 31, 2005. During your examination, you discover the following errors: a. As a result of errors in the physical count, ending inventories were misstated as follows: December 31, 2004 December 31, 2005

P14,000 understated P23,000 overstated

b. On December 29, 2005, Branzuela recorded as a purchase, merchandise in transit, which cost P15,000. The merchandise was shipped FOB Destination and had not arrived by December 31. The merchandise was not included in the ending inventory. c. Branzuela records sales on the accrual basis but failed to record sales on account made near the end of each year as follows 2003 2004 2005

P4,000 5,000 3,500

d. The company failed to record accrued office salaries as follows: December 31, 2003 December 31, 2004

P10,000 14,000

e. On March 1, 2004, a 10% stock dividend was declared and distributed. The par value of the shares amounted to P10,000 and market value was P13,000. the stock dividend was recorded as follows: Miscellaneous expense Common stock Retained earnings f.

P13,000 10,000 3,000

On July 1, 2004, Branzuela acquired a three-year insurance policy. The three-year premium of P6,000 was paid on that date, and the entire premium was recorded as insurance expense.

g. On January 1, 2005, Branzuela retired bonds with a book value of P120,000 for P106,000. The gain was incorrectly deferred and is being amortized 10 years as a reduction of interest expense on other outstanding obligations. Questions: 1. What is the adjusted net income for the year ended December 31, 2003? a. P133,000 b. P121,000 c. P117,000 d. P113,000

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2. What is the adjusted net income for the year ended December 31, 2004? a. P159,000 b. P160,000 b. P179,000 c. P187,000 3. What is the adjusted net income for the year ended December 31, 2005? a. P129,600 b. P131,600 c. P139,600 d. P142,600 4. What adjusting entry should be made on December 31, 2005 to correct the error described in item B? a. Accounts payable 15,000 Purchases 15,000 b. Purchases 15,000 Accounts payable 15,000 c. Accounts payable 15,000 Cash 15,000 d. Accounts payable 15,000 Retained earnings 15,000 5. The adjusting entry on December 31, 2004 to correct the error described in item E should include a debit to a. Common stock P10,000 c. Additional paid in capital, P3,000 b. Retained earnings, P16,000 d. Miscellaneous expenses, P3,000 Solution Unadjusted Net Income A

2003 127,000

2004 150,000 14,000

4,000

(4,000) 5,000

B C D

(10,000)

E F G Adjusted Net Income Answer: 1. B

2. A

___________ 121,000 3. D

2005 128,500 (14,000) (23,000) 15,000 (5,000) 3,500

10,000 (14,000) 13,000 5,000

14,000 (2,000) 14,000 (1,400) 129,600

___________ 179,000 4. A

5. B

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