UNIT 1 ANALYSIS AND CORRECTION OF ERRORS Estimated Time: 2.

5 HOURS

Discussion questions 1-1 1. Define the following terms: a. Reclassifying entry b. Correcting entry c. Adjusting entry 2. What do books still open and books already closed mean? What is the impact of each on reclassifying, correcting, and adjusting entries? 3. What are prior period errors? Explain the treatment of prior period errors and provide two examples. 4. Differentiate counterbalancing and non-counterbalancing errors. Provide two examples each. Problem 1-1 Errors in recognizing deferrals and accruals Certain errors listed below were made by AAA Corporation. Indicate the effects of errors on the companys financial statements by inserting in the space O, U, and NE to indicate overstatement, understatement, and no effect, respectively.
Total Revenue A B C D E a. b. c. d. e. Failed to record insurance costs incurred but not paid. Failed to accrue interest on notes receivable. Failed to adjust unearned revenue for portion earned during the year. Failed to adjust supplies not used during the year. Failed to accrue salaries for the last five days of the year. Total expenses Total assets Total Liabilities Owners Equity

Problem 1-2 Errors in recognizing property, plant, and equipment and the related depreciation and bad debts
Pack Company's net incomes for the past three years are presented below: 2012 2011 2010 P480,000 P450,000 P360,000 During the 2012 year-end audit, the following items come to your attention: 1. Pack bought a truck on January 1, 2009 for P196,000 with a P16,000 estimated salvage value and a six-year life. The company debited an expense account and credited cash on the purchase date for the entire cost of the asset. (Straight-line method)

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2. During 2012, Pack changed from the straight-line method of depreciating its cement plant to the double-declining balance method. The following computations present depreciation on both bases: 2012 2011 2010 Straight-line 36,000 36,000 36,000 Double-declining 72,000 57,600 46,080 The net income for 2012 was computed using the double-declining balance method, on the January 1, 2012 book value, over the useful life remaining at that time. The depreciation recorded in 2012 was P72,000. 3. Pack, in reviewing its provision for uncollectibles during 2012, has determined that 1% is the appropriate amount of bad debt expense to be charged to operations. The company had used 1/2 of 1% as its rate in 2011 and 2012 when the expense had been P18,000 and P12,000, respectively. The company recorded bad debt expense under the new rate for 2009. The company would have recorded P6,000 less of bad debt expense on December 31, 2012 under the old rate.

1. Prepare in general journal form the entry necessary to correct the books for the transaction in item 1 of this problem, assuming that the books have not been closed for the current year. 2. Compute the net income to be reported for the year 2010. 3. Compute the net income to be reported for the year 2011. 4. Compute the net income to be reported for the year 2012. 5. Assume that the beginning retained earnings balance (unadjusted) for 2010 was P1,360,000. At what adjusted amount should this beginning retained earnings balance for 2010 be stated, assuming that comparative financial statements were prepared? 6. Assume that the beginning retained earnings balance (unadjusted) for 2012 is P1,500,000 and that non-comparative financial statements are prepared. At what adjusted amount should this beginning retained earnings balance be stated? Problem 1-3 Analysis of various errors The retained earnings account of Peter Pan Corporation is reproduced below:
Date 2010 Jan. 1 Dec. 31 2011 Jan. 10 Mar. 6 Dec. 31 2012 Jan. 9 Dec. 31 RETAINED EARNINGS Item Balance Net income for the year Dividends paid Stock sold excess over par Net loss for the year Dividends paid Balance P P 15,000 35,000 11,200 15,000 89,800 131,000 Debit P Credit 78,000 18,000

131,000

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The audit of the Companys financial statements December 31, 2012 reveals the following: a. Dividends declared on December 10, 2010 and 2011 had not been recorded in the books until paid. b. Improvements in buildings and equipment of P9,500 had been charged to expense at the end of April 2009. Improvements are estimated to have an 8-year life. Peter Pan Corporation computes depreciation to the nearest month and uses the straight-line depreciation. c. The physical inventory of merchandise had been understated by P3,000 at the end of 2010, and by P4,300 at the end of 2011. d. Merchandise in transit and to which the company had title at December 31, 2011 and 2012 was not included in the year-end inventories. These shipments of P3,500 and P5,800 were recorded as purchases in January of 2012 and 2013, respectively. e. The company had failed to record sales commissions payable of P2,000 and P1,500 at the end of 2011 and 2012, respectively. f. The company had failed to recognize supplies on hand of P1,200 and P2,500 at the end of 2011 and 2012, respectively. g. The company reported a net loss of P18,500 for the year ended December 31, 2012.

1. Prepare the necessary adjusting journal entries at December 31, 2012. 2. What is the corrected net loss of Peter Pan Corporation for the year ended December 31, 2012? Problem 1-4 Working paper preparation You have been engaged to prepare corrected financial statement figures for DDD, Inc. The records are in agreement with the following balance sheet:
DDD, Inc. Balance Sheet December 31, 2012 Assets Cash Accounts receivable Notes receivable Inventory P110,000 110,000 130,000 240,000 P590,000 Liabilities and Equity Accounts payable P100,000 Notes payable 30,000 Ordinary shares 200,000 Retained earnings 260,000 P590,000

A review of the records of the company indicates that the errors and omissions listed in the table that follows had not been corrected during the applicable years:

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Dec. 31 2009 2010 2011 2012

Inventory overstated P70,000 85,000 -

Inventory understated P65,000 95,000

Prepaid expense P9,000 8,000 7,000 6,000

Unearned revenue P4,000 3,000

Accrued expenses P2,000 650 1,000 600

The net income according to the records is P55,000, P85,000, and P60,000 for the years 2010, 2011, and 2012, respectively. No dividends were declared during these years and no adjustments were made to retained earnings.

Prepare (1) a working paper to arrive at the corrected net income for the years 2010, 2011, and 2012 and (2) a corrected balance sheet as of December 31, 2012. Problem 1-5 Comprehensive problem Captain Hook is in the process of obtaining a loan at Tinker Bell Bank. The bank has requested audited financial statements. Captain Hooks financial statements have never been audited before. It has prepared the following comparative financial statements for the years ended December 31, 2012 and 2011.
CAPTAIN HOOK COMPARATIVE STATEMENTS OF FINANCIAL POSITION December 31, 2012 and 2011 Assets Current assets: Cash and cash equivalents Accounts receivable Allowance for bad debts Inventory Total current assets Non-current assets: Property, plant, and equipment Accumulated depreciation Total non-current assets Total assets Liabilities and Shareholders Equity Liabilities: Accounts payable Shareholders equity: Ordinary shares, P20 par value; 150,000 shares authorized; 65,000 shares issued and outstanding Retained earnings Total shareholders equity P 607,000 P 980,500 2012 P 1,205,000 1,960,000 (185,000) 1,035,000 P 4,015,000 835,000 (608,000) 227,000 4,242,000 P 2011 800,000 1,480,000 (90,000) 1,010,000 3,200,000 847,500 (532,000) 315,500 3,515,500

1,300,000 2,335,000 3,635,000

1,300,000 1,235,000 2,535,000

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Total liabilities and shareholders equity

P 4,242,000

3,515,500

CAPTAIN HOOK COMPARATIVE INCOME STATEMENTS For the Years Ended December 31, 2012 and 2011 2012 Sales Cost of goods sold Gross income Operating expenses: Selling expenses Administrative expenses Total operating expenses Net income The 2012 audit revealed the following facts: a. On January 5, 2011, Captain Hook had charged a 5-year insurance premium to expense. The premium totaled P31,000. b. The amount of loss due to bad debts has steadily decreased over the last 2 years. Captain Hook has decided to reduce the amount of bad debt expense from 2% to 1 % of sales, beginning with 2012. (A charge of 2% has already been made for 2011). c. Captain Hook uses the periodic inventory system. The following are the inventory errors for the last 2 years. 2011 Ending inventory overstated by P75,000 2012 Ending inventory overstated by P99,500 d. An equipment costing P300,000 was acquired on January 3, 2011. The purchase was recorded by a charge to operating expense. The equipment has a useful life of 10 years and a residual value of P50,000. Captain Hook uses the straight-line method in depreciating its assets. P P 5,320,000 2,150,000 3,170,000 P P 2011 4,500,000 1,975,000 2,525,000 1,025,000 565,000 1,590,000 935,000

1,150,000 600,000 1,750,000 P 1,420,000

1. Prepare the adjusting journal entries to correct the books at December 31, 2012. Assume that the books for 2012 have not yet been closed. 2. What is Captain Hooks corrected net income for the year ended December 31, 2011? 3. What is Captain Hooks corrected net income for the year ended December 31, 2012?

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