SUMMIT PROFESSIONAL REVIEW CENTER

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AUDITING-PROBLEMS
Accounting Changes and Correction of Errors

Prior Period Errors - The entity shall correct prior period errors retrospectively in the first set of
financial statements authorized for issue after their discovery by restating the net income and retained
earnings of prior period.

Two types of prior period errors:

1. Counterbalancing errors
a. errors that affect both the net income of the year when the error was committed and the
immediate year thereafter in opposite directions.
b. affect pertinent real accounts only in the year of commission of error. Real accounts
subsequent to the year of error are already correctly stated.

Examples of counterbalancing errors:

a. Omission of Accrued Expenses
b. Omission of Unearned Income
c. Omission of Accounts Payable/Purchases
d. Omission of Prepaid Expenses
e. Omission of Accrued Income
f. Omission of Accounts Receivables/Sales
g. Understatement of Ending Inventories
h. Overstatement of Ending Inventories

2. Non-counterbalancing Errors
A. errors that affect only the net income of the year the error was committed. The net income
of the subsequent year is already correctly stated.
B. affect pertinent real accounts in the year the error was committed and all the subsequent
years, unless adjusted.

Problem 1:
The income statements of Christia Inc. indicate the following net income:
2013 P1,500,000
2014 1,750,000
2015 2,000,000
An examination of the accounting records for the year ended December 31, 2015 indicates that
several errors were made. The following errors were discovered:

a. Salary accruals on December 31 were consistently omitted:

2012 P95,000
2013 110,000
2014 100,000
2015 140,000

b. The footings and extensions showed that the inventory on December 31, 2014 was overstated by
P190,000.

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c. P150, 000 worth of inventories were received on January 4, 2015. Upon investigation you
discovered that these goods were shipped by the supplier on December 30, 2015 FOB shipping
Point. Further investigation revealed that liability on the item were recorded when the goods were
received.

d. Prepaid insurance were consistently omitted at the end of each year:

2012 P75,000
2013 100,000
2014 115,000
2015 120,000

e. Interest receivable was not recorded on December 31 of the following years:

2013 P20,000
2014 25,000
2015 30,000

f. On January 1, 2015 an equipment costing P400,000 was sold for 220,000. At the date of sale the
equipment had accumulated depreciation 240,000. The cash received was recorded by the company
as miscellaneous income.

g. You also discovered that on July 1, 2013, the company completed the construction of the left wing
of its factory building incurring a total cost of P750,000, which it had charged to repairs expense. The
said building has been used in operations for 5 years as of July 1, 2013 and its life was unaffected by
the extension. The building which had an origin cost P3,000,000 had an accumulated depreciation of
P1,125,000 as of December 31, 2015.

Required:
1. What is the correct depreciation expense in 2015?
a. 150,000 c. 200,000
b. 175,000 d. 187,500
2. What is the correct net income in 2013?
a. 2,365,000 c. 2,255,000
b. 2,235,000 d. 2,230,000
3. What is the correct net income in 2014?
a. 1,540,000 c. 1,640,000
b. 1,590,000 d. 1,690,000
4. What is the correct net income in 2015?
a. 2,100,000 c. 2,050,000
b. 2,000,000 d. 1,950,000

Problem 2:
You are performing for the first time the audit for the year ended December 31, 2014 of ABC Corp.
financial statements. The company reported the following amounts of net income for the years ended
December 31, 2012, 2013, 2014.

2012 P381,000
2013 450,000
2014 385,500

During your examination, you discovered the following errors:

a. You observed that there were errors in the physical count: December 31,2013 inventories were
understated by P 42,000 and December 31,2014 were overstated by P 69,000.

b. On December 30, 2014, GKNB recorded on account, merchandise in transit which cost P45,000.
The merchandise was shipped FOB Destination and had not arrived by December 31. The
merchandise was not included in the ending inventory.

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 c. Accrual sales at each year end were consistently omitted as follows:

2012 P12,000
2013 15,000
2014 10,500

d. Accrual of salaries were also consistently omitted as follows:

December 31,2012 30,000
December 31,2013 42,000

e. On March 5,2013 a 10% stock dividend was declared and distributed. The par value of the
shares amounted to 30,000 and market value was 39,000. The stock dividend was recorded as
follows:
Other expense 30,000
Ordinary shares 30,000

f. On July 1,2013 ABC paid three-year rent. The three-year premium of 18,000 was paid on that
date, and the entire premium was recorded as insurance expense.

g. On July 1,2014, ABC retired bonds with book value of P360,000 for P318,000. The gain was
deferred and amortized over 10 years as a reduction of interest expense on other outstanding
bonds.

5. What is the correct net income in 2012?

a. 399,000 b. 363,000 c. 351,000 d. 339,000

6. What is the correct net income in 2013?

a. 477,000 b. 498,000 c. 528,000 d. 534,000

7. What is the correct net income in 2014?

a. 313,200 b. 388,800 c. 393,000 d. 418,800

8. What is the retroactive adjustment to the beginning retained earnings in 2014 to correct the
prior years’ errors?
a. 21,000 cr. b. 21,000 dr. c. 69,000 dr. d. 69,000 cr.

9. What is the adjusting entry in 2014 to correct the error in item e above?
a. Accumulated profits 39,000
Other expense 30,000
Share premium 9,000

b. Accumulated profits 30,000

Accumulated profits 30,000

c. Accumulated profits 9,000

Share premium 9,000

d. no adjustment necessary

Problem 3:
You were engaged by Ken Corp. to audit its financial statements for the first time. In examining the
company's books, you discovered that other items had been erroneously recorded. The omissions
and other failures for each year are noted below:

2014 2015
Prepaid insurance 270,000 195,200
Accrued salaries and wages 592,400 510,000
Accrued interest income 180,200 152,000
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Advances from customers 330,600 380,000
Capital expenditures charged as repairs expense 350,000 370,000

Audit notes:
a. Collection from customers had been recorded as sales but should have been recognized as
advances from customers because goods were not shipped until the following year.

b. Capital expenditures had been recorded as repairs but should have been charged to the
machinery account; the depreciation is 10% per year, but depreciation in the year of
expenditure is to be recognized at 5%.

Based on the above and the result of your audit, answer the following:

10. What is the total effect of the errors on the 2015 net income?

a. Understated by 300,000 c. Understated by 316,500

b. Overstated by 335,000 d. Overstated by 353,800

11. What is the total effect of the errors on the company's working capital?
a. Understated by 202,200 c. Understated by 177,200
b. Overstated by 79,600 d. Overstated by 546,800

12. If remained unadjusted, what will be the effect of the errors to the company's December 31, 2015
accumulated profits?
a. Understated by 176,200 c. Understated by 177,200
b. Overstated by 620,600 d. Overstated by 570,600

“Life is really simple, but we insist on making it complicated.”

Confucius

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