Chapter 35

CHAPTER 35
Additional Aspects of Financial Reporting

Accounting Policies, Changes in
Accounting Estimates and Errors
Essay Questions
Q35-1. a. A change in principle a different generally accepted accounting

principle or procedure is adopted.
b. A change in estimate a prior estimate is changed based upon more
current and improved information.
c. An accounting error facts existing at the time of an event or exchange
transaction were incorrectly recorded or a transaction was not recorded at
all.
Q35-2. A pro forma amount is an as if earnings amount; required only with respect
to reporting the effects of changes in accounting principle (that require current
application) to satisfy the qualitative characteristic of comparability.
Q35-3. An accounting change involves a change in accounting (a) principle, (b)

estimate, or (c) entity. It is made with intent and by decision. An accounting
error involves incorrect application of accounting principles and estimates, and
mathematical errors. Accounting errors usually are made inadvertently and are
not planned.
Q35-4. The book value is treated as if it were the new original cost. The revised
residual value is subtracted from the book value, resulting in revised
depreciable cost, the basis for subsequent depreciation.
Q35-5. A company could justify a change in accounting principle on the grounds that
the new principle is preferable to the old. One example would be a change
from LIFO to FIFO, because the change results in a more meaningful
matching of costs with revenues. Another example would be a change from
completed-contract method to percentage-of-completion method.
Q35-6. Since accounting involves periodic reporting and matches costs as expenses
against revenues, it necessarily involves estimation. Changes in estimates are
inevitable as new events occur, more experience is acquired, or additional
information is obtained. Some examples of changes in accounting estimates
include a change in the estimated useful life of an asset, a change in estimated
35-2 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)
warranty costs because of a newly discovered defect, a change in the estimated

amount of uncollectible accounts receivable, and a change in the estimated
amount of recoverable mineral reserves.
A company accounts for a change in accounting estimate in the period of
change if it affects that period only, or in the period of change and future
periods if it affects both. A change in accounting estimate does not require a
cumulative effect adjustment or prior period restatement.
Q35-7. A material error of a prior period that is discovered in the current period is
accounted for as a prior period adjustment (restatement) and therefore is
excluded from net income. On the current period financial statements, the
company reports the error (net of related income tax effects) as an adjustment
to the beginning balance of retained earnings. When comparative statements
are presented, it makes adjustments to the affected items on the statements of
profit or loss and other comprehensive income and to the retained earnings
balances, as well as the balances of the affected statement of financial position
accounts for all periods reported. In addition, the company discloses the
nature of the error in previously issued financial statements and the effect of
its correction on net income and the related earnings per share amounts for
each year reported.
Q35-8. A counterbalancing (self-correcting) error results from failure to properly

allocate an expense or revenue item between two consecutive accounting
periods. No error remains in retained earnings or other statement of financial
position accounts at the end of the second period because the total revenue and
total expense to that date are correct. However, the interim reports are
incorrect.
A noncounterbalancing (not self-correcting) error continues to affect the
account balances and reports beyond a two-year period.
This distinction is significant in the analysis of errors because the correcting
entry depends upon whether the error is counterbalancing or
noncounterbalancing, as well as upon when the error is corrected relative to
when the error was made.
Q35-9. Errors that affect only a companys statement of financial position are mainly
classification errors. These include classifying a long-term note receivable as
a current receivable and failing to include the current portion of long-term debt
in current liabilities.
Q35-10. Errors that affect only a companys statement of profit or loss and other
comprehensive income usually result from misclassification of items.
Examples of this include combining interest revenue with sales revenue and
including selling expenses in cost of goods sold.
AdditionalAspectsofFinancialReporting-AccountingPolicies,ChangesinAccountingEstimatesandErrors 35-3
Q35-11. One example of an error that is counterbalanced in the following period is the
failure to accrue an interest liability in the current period when the interest is
to be paid in the next period. The effect of this error in the current period is to
understate interest expense and thus overstate net income and retained
earnings, and to understate interest payable. In the following period when the
interest is paid and treated as an expense, interest expense is overstated and net
income is understated by the same amount as it was overstated in the previous
period. Therefore, at the end of the second period, retained earnings is
correctly stated.
Another example of an error that is counterbalanced in the following period is
the overstatement of ending inventory under a periodic inventory system. In
the current period, cost of goods sold is understated, which results in net
income and retained earnings being overstated. In the following period,
however, beginning inventory is overstated, so cost of goods sold is overstated
and net income is understated, which results in retained earnings being
correctly stated at the end of the second period.
Q35-12. One error that is not counterbalanced in the following period is the expensing
of a depreciable fixed asset in the period it is purchased. In the year of
purchase, expenses are overstated, assets are understated, depreciation expense
is understated, and accumulated depreciation is understated. The
understatement of the asset and depreciation expense will continue over the
life of the asset. The statement of financial position accounts (Asset,
Accumulated Depreciation, and Retained Earnings) will only be correct upon
the disposal of the asset.
Another noncounterbalancing error is the failure to record properly a bond
discount or premium. This causes interest expense to be incorrectly reported
and liabilities and net income to be incorrect for the life of the bonds.
Q35-13. If discovery occurs in 2015, a prior period adjustment is recognized to correct

the overstatement of 2014 net income, and wage expense is reduced to correct
overstatement in 2015. If discovery occurs in 2016, no entry is needed
because the overstatement of 2014 income affecting retained earnings is offset
by the understatement of 2015 income. The errors have counterbalanced.
Q35-14. a. Affects statement of profit or loss and other comprehensive income only:
(1) Interest revenue credited to dividend income, or vice versa.
(2) Loss on sale of equipment debited to operating expense, or vice
versa.
b. Affects statement of financial position only:
(1) Credit long-term liability amount to short-term liability, or vice versa.
(2) Credit premium on par value shares to the share capital amount, or
vice versa.
c. Affects both statement of profit or loss and other comprehensive
income and statement of financial position:
(1) Error in merchandise inventory.
(2) Error in prepaid expense (e.g., prepaid expense recorded as expense).
Q35-15. Effect of Error On

Net Owners
Income Assets Liabilitie Equity
s
a. Ending inventory for 2014
understated:
2014 financial statements........... 0
2015 financial statements........... + 0 0 0
b. Ending inventory for 2015
overstated:
2015 financial statements........... + + 0 +
2016 financial statements........... 0 0 0
c. Failed to record depreciation in
2014:
2014 financial statements........... + + 0 +
2015 financial statements........... 0 + 0 +
d. Failed to record revenue collected in
advance at end of 2014 (was
reported as revenue):
2014 financial statements........... + 0 +
2015 financial statements........... 0 0 0
Q35-16. A change in accounting principle occurs when one generally accepted

accounting principle is adopted in place of the one used previously for
reporting purposes. A change in estimate results from new events occurring,
more experience being acquired, or additional information being obtained that
necessitates a revision of an accounting estimate previously made. It is often
difficult to distinguish between a change in principle and a change in estimate
because they are interdependent. For example, a change in the estimated
productive use of equipment may cause a change in the method of
depreciating that equipment. A company accounts for a change in accounting
principle as a cumulative effect in the year of change, with a few exceptions,
and accounts for a change in estimate prospectively. A company accounts for
a change in accounting principle that is associated with a change in estimate
prospectively.
Q35-17. The following changes in accounting principle require prior period restatement
(retroactive adjustment) instead of cumulative effect disclosure: (1) a change
from the LIFO method of inventory pricing to another cost flow method; (2) a
change in the method of accounting for long-term construction-type contracts;
(3) a change to or from the full-cost method of accounting, used in the
extractive industries, (4) a change from retirement-replacement-betterment
accounting to depreciation accounting, for railroad track structures; and (5) a
change from the fair value method to the equity method for investments in
ordinary shares. The reason for restating prior periods for these changes
instead of showing the cumulative effect in the current year is that the size of
the cumulative effect of the change may be so much greater than operating
income that including it in the statement of profit or loss and other
comprehensive income might appear to reduce the significance of income
from operations. Prior period restatement is also required when a change is
made to a new accounting principle in order to conform to requirements set
forth in PAS.
Q35-18. PAS 34 defines the principles to be followed in reporting accounting changes

in interim statements. If a company makes a cumulative effect type of
accounting change during the first interim period, it includes the cumulative
effect of the change on retained earnings at the beginning of the year in the net
income of the first interim period. However, if a company makes a cumulative
effect type of change in other than the first interim period, it restates the prior
interim periods by applying the newly adopted principle to those interim
periods, and reports the cumulative effect of the change on retained earnings at
the beginning of the year in the restated net income of the first interim period.
For those changes in accounting principle for which the cumulative effect
cannot be determined, disclosure of the change is necessary but no
adjustments are required if the change occurs in the first interim period. If a
company makes the change in other than the first interim period, it restates the
financial statements of the prechange interim periods by applying the newly
adopted accounting principle to those prechange interim periods.
Q35-19. A company corrects errors even after they have counterbalanced whenever it
presents for comparative purposes financial statements affected by the error.
Otherwise, the errors may cause financial statements to be misleading to users
by distorting trends and financial ratios.
Exercises
E35-1. The cited items are reported as follows:

1. Change in accounting principle; exception to general rule; prior period

restatement; at the beginning of the period, increase retained earnings and
inventory; assuming rising prices during the period, net income and assets
are higher than they otherwise would have been.
2. Change in accounting estimate; general rule; revise periodic depreciation
charge based on current book value, estimated residual value, and new
estimate of remaining service life for current and future periods; no effect
at the beginning of the period; depreciation expense is higher and net
income and assets are lower than they otherwise would have been in the
current period.
3. Change in accounting estimate; general rule; revise periodic depreciation
for the current and future periods; usually a change from accelerated
depreciation to straight-line depreciation will increase income and assets
but it may decrease income and assets if all assets are near the end of their
useful lives.
4. Change in accounting estimate; general rule; charge to income in current
period; decrease income and current assets.
5. Included in income of the current period; therefore, income and assets
increase.
6. Correction of accounting error; general rule; prior period adjustment;
increase assets and retained earnings at the beginning of the period;
during the period, more depreciation will be charged than otherwise
would have been.
7. Charge to current income; decrease assets and net income.
restatement; probably increase assets and retained earnings at the
beginning of the period; during the period, assets and net income
probably will be higher than they otherwise would be.
E35-2. The cited items are reported as follows:

1. Change in accounting principle; exception to general rule since
cumulative effect not determinable; disclosure of the effect of the change
on results of operations (including per share data) for the period of change
and prior period profit if affected; if prices are rising, cost of goods sold is
higher and net income lower than they otherwise would be in the current
period.
period; decrease net income and assets.
3. Include in income of the current period; decrease net income and assets.

and future periods; decreases net income and current assets in the current
period.
5. Change in accounting estimate; general rule; a change from straight-line
to double-declining-balance depreciation will decrease assets and net
income; during the current period, depreciation expense is probably
higher and net income and assets lower than they otherwise would have
been.
6. Change in accounting estimate (contingency); general rule; charge to
current income; decrease assets and net income.
restatement; probably decrease retained earnings and assets at the
beginning of the period; during the period, net income and assets are
probably lower than they otherwise would have been.
E35-3. Requirement 1
The total change in cost of goods sold prior to 2015 of P180,000 (P85,000 +
P50,000 + P45,000) decreases the value of the inventory by that amount. The
inventory value using the FIFO cost flow assumption was greater than it
would have been had the average cost flow assumption been used since the
FIFO assumption charged lower costs to cost of goods sold and left the higher
costs in inventory. The journal entry is:
Retained earnings prior period adjustment
due to change from FIFO to Average cost................. 126,000
Income taxes receivable............................................... 54,000
Inventory............................................................... 180,000
Requirement 2
Comparative Statements of Profit or Loss and Other Comprehensive Income
2015 2014
Revenues P1,750,000 P1,500,000
Expenses (1,050,000) (945,000)
Income before income taxes P 700,000 P 555,000
Income tax expense (210,000) (166,500)
Net income P 490,000 P 388,500
Earnings per ordinary share (100,000 shares) P4.90 P3.89
Pro forma amounts assuming the new cost

flow assumption is applied retroactively:
Net income P490,000 P388,500 a
Earnings per ordinary share P4.90 P3.89

a
(P600,000 P45,000) x (1 0.30)
Note: Inventory has been valued using the average cost flow assumption in
2015. In prior years, inventory was valued using the FIFO cost method. The
new method of inventory valuation was adopted to . . . (state justification for
change in accounting principle) . . . and has been applied retroactively to
inventory valuations of prior years. The pro forma amounts shown on the
statement of profit or loss and other comprehensive income have been
adjusted for the effect of retroactive application of the new method on
inventory and related income taxes.
Inventory .............................................................. 6,000
Retained earnings (P6,000 x 0.70)................. 4,200
Income taxes payable (P6,000 x 0.30)........... 1,800
Requirement 2
Comparative Statements of Profit or Loss and Other Comprehensive Income
2015 2014
Revenues P300,000 P270,000
Cost of goods sold (55,000) (39,000)
Other expenses (70,000) (75,000)
Income before income taxes P175,000 P156,000
Income tax expense (52,500) (46,800)
Net income P122,500 P109,200
Earnings per share (15,000 shares) P8.17 P7.28
Requirement 3
Comparative Retained Earnings Statements
Beginning unadjusted retained earnings P105,000 a P 0

Plus: Prior period adjustment (net of income
taxes of P1,800) 4,200 0
Adjusted beginning retained earnings P109,200 P 0
Add: Net income 122,500 109,200
Ending retained earnings P231,700 P109,200
a
(P270,000 P120,000) x 0.70
E35-5. 1. Purchases............................................................... 10,000

Retained earnings........................................... 10,000
2. Machinery.............................................................. 2,000
Accumulated depreciation: Machinery.......... 400
or
Machinery.............................................................. 2,000
Retained earnings.................................................. 400

Accumulated depreciation: Machinery.......... 400
3. If the error is discovered after the first wage payment for the year, which
is most likely, the entry would be:
Retained earnings.................................................. 2,000
Wages expense............................................... 2,000
4. Rent expense......................................................... 4,000

5. If discovered during the following year:

Allowance for doubtful accounts................... 5,000
If discovered after the accrual for uncollectibles is made at the end of the
following year:
Bad debt expense........................................... 5,000
6. Retained earnings.................................................. 11,000

Discount on note receivable........................... 11,000
or
Retained earnings.................................................. 21,000 a
Discount on note receivable........................... 21,000 a
To correct sale.
Discount on note receivable.................................. 10,000 b

Retained earnings........................................... 10,000 b
To correct interest revenue in the first year.

a
P121,000 (P121,000 x 0.826446)
b
10% x (P121,000 P21,000)
E35-6. Assets Liabilities Owners Equity Net Income

1. + NE + +
2. NE + +
3. NE
4. NE + +
5. + NE + +
6. NE + +
7. NE
8. NE + +
9. + + + +
10. + NE + +
Computation of correct income:
2013 2014 2015
Reported net income P20,000 P25,000 P23,000
Prepaid expenses:
Add back expense in year paid 500 900 1,100
Deduct expense in year incurred (500) (900)
Accrued expenses:
Deduct expense in year incurred (800) (700) (950)
Add back expense in year paid 800 700
Revenue received in advance
(unearned):
Deduct revenue from year received (300) (400) (1,300)
Add revenue in year earned 300 400
Revenue earned but not received
(accrued):
Deduct revenue from year received (600) (1,000)
Add revenue in year earned 600 1,000 1,200
Corrected net income P20,000 P25,800 P22,250
Requirement 2
The following individual journal entries may be used to correct the errors.
Prepaid expenses:
Prepaid expense..................................................... 1,100
Expense.......................................................... 1,100
Expense................................................................. 900
Retained earnings........................................... 900
Accrued expenses:
Expense ................................................................ 950
Liability.......................................................... 950
Expense.......................................................... 700
Revenue received in advance (unearned):

Revenue ................................................................ 1,300
Liability.......................................................... 1,300
Revenue.......................................................... 400
Revenue earned but not received (accrued):
Asset...................................................................... 1,200
Revenue.......................................................... 1,200
Revenue ................................................................ 1,000
Alternatively, the following compound journal entry could be made (assuming

the expense account corrections can be offset).
Prepaid expenses.......................................................... 1,100
Accounts receivable...................................................... 1,200
Expenses....................................................................... 50
Revenue........................................................................ 700
Accrued expenses.................................................. 950
Unearned revenue.................................................. 1,300
Requirement 3
The following individual journal entries may be used to correct the errors in
2016:
Expense................................................................. 1,100

Expense.......................................................... 950
Revenue.......................................................... 1,300
Revenue ................................................................ 1,200
Alternatively, the following compound journal entry could be made (assuming

the expense account corrections can be offset).
Expenses................................................................ 150
Revenue.......................................................... 100
Current receivables................................................ 90,000 *
Retained earnings prior period
adjustment due to change in method
in accounting installment sales................... 90,000
* P70,000 + P20,000
Requirement 2
2014 2015
Net income....................................................... P100,000 b P130,000 a
Pro forma net income....................................... 100,000 b 130,000 c
a
P100,000 + P30,000
b
P80,000 + P20,000
c
P100,000 + P30,000
This is a change in accounting estimate and will require no retroactive
restatement. It can be assumed that the depreciation expense of P10,000 taken
up in 2015 already considered the remaining method depreciation cost or book
value under the old method at the beginning of that year, the remaining useful
life and salvage value, if any. Hence, there is no entry needed to record the
accounting change.
Requirement 2
There will be no change in the reported earnings for 2014. The amount to be
reported is P50,000.
Requirement 3
The 2015 annual report will disclose the change from accelerated method to
straight-line depreciation and the difference in amounts under the two
methods.
This is a change in accounting principle because the method of inventory is
being changed and therefore, the retroactive approach must be used. This
approach means that (a) an entry must be made for the catch-up adjustment as
of the beginning of the year of change, (b) the comparative statements must be
restated to the new basis to be comparable, and (c) the beginning balance of
retained earnings for all years reported must be adjusted for any change effect
prior to those years. Pro forma reporting is not required.
Requirement 2
Analysis of the accounting change:
To January 1, 2014, increase in retained earnings = (P30,000 P20,000) =
P10,000 pretax (P7,000 after tax)
To January 1, 2015, increase in retained earnings = (P70,000 P40,000) =
P30,000 pretax (P21,000 after tax)
For 2014:
Beginning inventory effect
P30,000 P20,000 =................. P10,000 increase in CGS under FIFO
Ending inventory effect
P70,000 P40,000 =................. P30,000 decrease in CGS under FIFO
Net effect on CGS..................... P20,000 decrease in CGS under FIFO
(Therefore pretax income is P20,000 higher under FIFO, and net income is
P14,000 higher).
For 2015:
Beginning inventory effect
P70,000 P40,000 =................. P30,000 increase in CGS under FIFO
Ending inventory effect
P76,000 P44,000 =................. P32,000 decrease in CGS under FIFO
Net effect on CGS..................... P 2,000 decrease in CGS under FIFO
(Therefore pretax income is P2,000 higher under FIFO, and net income is
P1,400 higher).
January 1, 2015 (year of change) To record the catch-up adjustment:

Inventory (adjust to beginning FIFO basis:
P70,000 P40,000)............................................ 30,000
Deferred income tax (P30,000 x 30%)........... 9,000
Retained earnings, adjustment due to
accounting change [P30,000 x
(100% 30%)]............................................ 21,000
Requirement 3
FIFO Basis
2014 2015
Comparative statement of financial position:
Inventory, FIFO................................................ P 70,000 P 76,000
Retained earnings (below)............................... 157,000 177,000
Comparative statement of profit or loss and

other comprehensive income for year:
Net income:
2014: Restated to FIFO basis (P80,000,
given + P14,000, Req. 2)............ P 94,000
2015: (Given, FIFO basis)....................... P 90,000
Earnings per share (10,000 shares). . . P9.40 P9.00

Comparative retained earnings statement:
Beginning balance (2015, given),
as previously stated........................... P120,000 P136,000*
Cumulative effect of accounting change. . 7,000 21,000
Beginning balance restated................ 127,000 157,000
Net income (FIFO basis from above)....... 94,000 90,000
Dividend declared and paid (given)......... (64,000) (70,000)
Ending balance......................................... P157,000 P177,000
* December 31, 2014 RE balance = P12,000 + P80,000 P64,000 = P136,000
Requirement 4
Footnote to the comparative statements:
During 2015, the firm changed from LIFO to FIFO for inventory accounting
purposes because FIFO more realistically measures income. The change
increased 2014 net income P14,000 (P1.40 per share) and 2015 net income
P1,400 (P0.14 per share).
E35-11. Accounting treatment for the cited events:

1. Change in accounting estimate; general rule; financial statements from all
prior periods are not restated retroactively.
2. Correction of an accounting error; general rule; prior period adjustment.
3. Change in accounting estimate; general rule; same treatment as in (1).
4. There is no change in accounting principle. The adoption of the
accelerated depreciation method on the new type of machine does not
constitute change in accounting principle because the nature of
transaction differs in substance from previously occurring transactions.
5. Correction of an accounting error; general rule; prior period adjustment.
E35-12. 1. Retained earnings.................................................. 6,300

Accumulated depreciation: Machinery................ 700
Machinery...................................................... 7,000
or
Machinery...................................................... 7,000
Accumulated depreciation: Machinery................ 700
2. Construction in progress........................................ 22,000
Note to Instructor: This assumes that no physical inventory was taken,
which is consistent with the discovery of the error in 2015.
3. Inventory............................................................... 10,000 a
a
(3,000 12,000) x P40,000
Problems
P35-1. Requirement 1
Correcting entries:
a. Prior period adjustment correction

(patent amortization, 2013)................................ 3,000
Patent amortization, expense, 2014....................... 3,000
Patent.............................................................. 6,000
b. No correcting entry because this error self corrected by the end of 2013.
For the 2014 comparative financial statements (which include 2013), the
P4,000 inventory (beginning) overstatement (for 2013) would have to be
incorporated into the 2013 statements for comparability reasons.
c. Accumulated depreciation (P600 x 5 yrs.)............ 3,000
Depreciation expense, 2014........................... 600
Prior period adjustment, correction
(depreciation, P600 x 4 yrs.)....................... 2,400
Computations:
Depreciation recorded per year (P26,000 10 yrs.).... P2,600
Correct amount of depreciation per year
[(P26,000 P6,000 = P20,000) 10 yrs.]................. 2,000
Depreciation overstatement per year............................ P 600
d. Prior period adjustment, correction (wages)......... 1,500
Wage expense, 2014....................................... 1,500
e. Cash shortage (expense)........................................ 1,000
f. To correct the entry made in January 2014:
Repair expense, 2014............................................ 7,000
Machinery...................................................... 7,000
Presumably the company recorded depreciation based on the balance in
the machinery account; therefore, depreciation on this P7,000 was
included in depreciation expense for 2014. The excess depreciation must
be reversed in 2014.
Accumulated depreciation (P7,000
6 years remaining).............................................. 1,167
Depreciation expense, 2014........................... 1,167
g. The difference between the cost and selling price of treasury shares is
properly recorded as a change in contributed capital. A corporation
cannot recognize a gain (loss) by dealing in its own share capital.
Gain on sale of treasury shares.............................. 3,000
Contributed capital from treasury
share transactions........................................ 3,000
Requirement 2
2014
Tentative pretax income (given)............................................... P85,000
Corrections:
a. Patent amortization (debit)................................................ (3,000)
b. No effect on net income.................................................... -0-
c. Depreciation expense (credit)............................................ 600
d. Wage expense (credit)....................................................... 1,500
e. Cash shortage (debit)......................................................... (1,000)
f. Repair expense (debit)....................................................... (7,000)
Depreciation correction (credit)........................................ 1,167
g. Gain (debit)........................................................................ (3,000)
Correct 2014 pretax income.............................................. P74,267
Correcting and adjusting entries:
a. December 31, 2014 To correct the account related to machine:
Prior period adjustment, correction (machine)...... 3,200
Machine (original cost)......................................... 10,000
Depreciation expense, 2014.................................. 800
Accumulated depreciation: (P800 x 5 yrs.).... 4,000
Land............................................................... 10,000
Computations:
Annual depreciation: (P10,000 P2,000 = P8,000) 10 yrs. = P800.
Prior period adjustment: P800 x 4 yrs. = P3,200.
b. December 31, 2014 To correct all accounts affected by the discount on

the long-term investment of P2,000 (i.e., P20,000 P18,000). The
carrying amount of the bond should be increased each year from P18,000
(cost) to P20,000 (maturity value) at the end of 2012. The amortization
credit should be to investment revenue; P200 per year (i.e., P2,000 10
years, straight-line):
LT investment bonds (P200 x 3 yrs.)..................... 600

Investment revenue, 2014.............................. 200
Prior period adjustment (bond discount)
(P200 x 2 years).......................................... 400
c. The 2014 beginning inventory (periodic system) is overstated by P7,000.

Income for 2013 was overstated by the same amount. The beginning
inventory account has not been closed for 2014.
Prior period adjustment, correction (inventory).... 7,000
Inventory, beginning 2014............................. 7,000
d. Because the purchase was not recorded at the proper time, December 18,
2013, pretax income for 2013 was overstated by P11,000. Also, the error
caused 2014 purchases to be overstated.
Prior period adjustment, correction (purchases). . . 11,000
Purchases, 2014.............................................. 11,000
Requirement 2
Restatement of 2014 pretax income:
Pretax income tentatively computed........................................... P160,000
a. Depreciation expense, 2014 (understated)........................... (800)
b. Investment revenue, 2014 (understated).............................. 200
c. Inventory 2014, beginning (overstated)............................... 7,000
d. Purchases, 2014 (overstated)............................................... 11,000
Correct pretax income, 2014................................................ P177,400
P35-3. a. To correct the 2015 beginning inventory, which is incorrect because the
2014 ending inventory was incorrect, and to correct 2015 purchases
(which are overstated):
Inventory, beginning, 2015.................................... 12,000
Purchases, 2015.............................................. 12,000
Notes: 2014 income was correct because the errors in 2014 purchases
and 2014 ending inventory offset each other in 2014.
Also, no correction is needed to accounts payable (although it
was understated at the end of 2014) because the payable would
not exist after payment was made in January 2015.
b. To correct the error in 2014 income due to the understatement of 2014

purchases, and to correct for the consequent overstatement of 2015
purchases:
* Prior period adjustment, error correction
(for 2014 income)............................................... 18,000
Purchases, 2015.............................................. 18,000
Accounts payable were understated in 2014 but are correct in 2015

because payment has been made.
c. To correct the error in 2014 net income which was overstated because bad
debt expense was not recorded in 2014. Also, the allowance account must
be corrected:
(for 2014 income)............................................... 2,000
Allowance for doubtful accounts................... 2,000
d. To correct the error in 2014 income, due to the understatement of selling

expense, and the consequent overstatement of 2015 selling expense:
(selling expense)................................................. 5,000
Selling expense, 2015.................................... 5,000
The liability for selling expense was understated at the end of 2014, but it
is correct in 2015 after the cash payment.
e. To correct the error in 2014 income because of the understatement of

wage expense, and to correct 2015 wage expense:
(wages)............................................................... 4,000
Wage expense, 2015....................................... 4,000
Although wages payable was understated at the end of 2014, it is correct

in 2015 after the January 2014 payment.
f. To correct the understatement of 2014 income because 2014 insurance

expense was overstated, and to correct 2015 insurance expense:
Insurance expense, 2015....................................... 600
Prior period adjustment, error correction
(insurance)................................................... 600
Prepaid insurance at the end of 2015 is correct should be zero.
g. To correct the overstatement of 2014 income due to income tax expense

not recorded until 2015, and correction of 2015 income tax expense
(overstated):
(income tax)........................................................ 2,400
Income tax expense, 2015.............................. 2,400
Income tax payable was understated at the end of 2014; however, 2015
income tax payable is correct because it has been paid.
h. To correct the overstatement of 2014 income due to the failure to record

depreciation expense in 2014, and to correct accumulated depreciation.
(depreciation)..................................................... 9,000
Accumulated depreciation.............................. 9,000
* Closed directly to retained earnings.
This case involves correction of an accounting error.
Analysis of the effects:
Asset recorded, equipment........................................... None
Asset that should have been recorded, equipment....... P9,000
Depreciation recorded on equipment........................... None
Depreciation that should have been recorded
per year on equipment (SL: P9,000 10 yrs.)...... P 900
Cumulative depreciation through 2014 (P900 x 4)...... P3,600
Error in statement of profit

or loss and other
comprehensive income:
2011 2012 2013 2014
Reported net income...... P11,000 P22,000 P30,000 P33,000
To correct net income
(tax effect disregarded):
2011 error correction... + 9,000
Annual depreciation
correction................. 900 900 900 900
Correct net income...... P19,100 P21,100 P29,100 P32,100
Requirement 2
To correct the current account balances, December 31, 2014:
Asset, equipment................................................... 9,000
Prior period adjustment*
[P9,000 (P900 x 3)].................................. 6,300
Accumulated depreciation, equipment
(2009, 2010 & 2011)................................... 2,700
* Closed to retained earnings.

December 31, 2014 Adjusting entry for 2014 depreciation:
Depreciation expense............................................ 900
Accumulated depreciation, equipment........... 900
Requirement 3
Presentation on 2014 financial statements (retroactive approach, prior periods
corrected):
Comparative statement of financial position:

2013 2014
Asset, equipment (Note 6)............................... P9,000 P9,000
Accumulated depreciation, equipment............. (2,700) (3,600)
Book value................................................ P6,300 P5,400
Retained earnings statement:

2013 2014
Beginning balance, as previously stated.......... P xx P xx
Adjustments to retained earnings..................... 7,200* 6,300
P xx P xx
* P6,300 + P900 = P7,200 alternatively, [P9,000 (P900 x 2) = P7,200)].

The amount recorded in the 2014 entry, covering years before 2014.

other comprehensive income:
2013 2014
Depreciation expense, equipment (Note 6)...... P 900 P 900
Net income:
2013 (P30,000 P900)............................. 29,100
2014 (P33,000 P900)............................. 32,100
Earnings per share (100,000 shares)................ P0.291 P0.321
Note 6: Correction of accounting error During 2014 it was discovered that

the cost of equipment acquired in 2011 was debited to expense at that time.
As part of the correction of the error, it was necessary to restate 2013 financial
statements to report depreciation expense for 2013 which was not reported as
a result of the error. Accordingly, 2013 net income is P900 less and the book
value of equipment reported above for 2013 is P6,200 more (i.e., P9,000
P2,700) than previously reported in 2013. Retained earnings at December 31,
2013 is P6,300 (i.e., P9,000 P2,700) more than previously reported.
2015 Depreciation before accounting change:

(P10,000 P1,000) x 2/6................................................................ P3,000
2015 Depreciation after accounting change:

Book value, January 1, 2015 = P10,000 (P9,000 x 3/6) = P5,500
2015 depreciation = (P5,500 P2,000) x 4/10
(at January 1, 2015, four years remaining)..................................... P1,400
2015 entry to record depreciation:

Depreciation expense............................................ 1,400
December 31, 2015 Accumulated depreciation balance:

2014 depreciation (P9,000 x 3/6)................................. P4,500
2015 depreciation......................................................... 1,400
2015 ending Accumulated depreciation................ P5,900
Requirement 2
Red Company
Statements of Profit or Loss and Other Comprehensive Income
For Years Ended December 31
2014 2015
Revenues.......................................................... P40,000 P50,000
Expenses and other losses other than
depreciation and tax..................................... (25,000) (35,000)
Depreciation expense....................................... (4,500) (1,400)
Net income before tax...................................... 10,500 13,600
Income tax expense (30%)............................... (3,150) (4,080)
Net income....................................................... P 7,350 P 9,520
Income on a per share basis: P0.074 P0.095

This is a change in accounting estimate and should be accounted for by using

the current approach (i.e., the catch-up adjustment is recorded in the year of
change and reported on the statement of profit or loss and other
comprehensive income) as well as prospective approach.
Requirement 2
a. Prior years income will not be adjusted because the change from SYD to
SL method is considered a change in accounting estimate.
b. To record SL depreciation for 2014:

Depreciation expense............................................ 3,500 **
Accumulated depreciation, equipment........... 3,500 **
** Cost P68,000
Less: Accumulated depreciation, SYD 34,000
Net book value, 1.1.05 P34,000

P34,000 P13,000
2014 depreciation (SL) = 6 = P3,500
Requirement 3
2013 2014
Comparative statement of financial position,

December 31:
Equipment (at cost).......................................... P68,000 P68,000
Accumulated depreciation (Note 4)
2014 SYD (from above).................................. (34,000)
2014 SL (P34,000 + P3,500)............................ (37,500)
Carrying value.................................................. P34,000 P30,500
other comprehensive income for year:
Income prior to depreciation and accounting

change (given) P55,000 P57,500
..................................................................
Depreciation expense....................................... SYD SL (3,500)
(7,000)
Net income....................................................... P48,000 P54,000
Earnings per share (100,000 shares)................ P0.48 P0.54
Note 4: Change in accounting method During 2014 the company changed
the method of depreciating some of its equipment from sum-of-the-years-
digits to straight-line. The change was made to achieve a more realistic
matching of expense and revenue.
a. Clients entries:
Building................................................................. 60,000
Notes payable................................................. 60,000
Depreciation expense: Building

(P60,000 30).................................................... 2,000
Accumulated depreciation: Building............ 2,000
Correct entries:
a
Building................................................................. 40,981
Discount on notes payable..................................... 19,019
Notes payable................................................. 60,000
a
P60,000 x 0.683013
Depreciation expense: Building........................... 1,366 b

Interest expense..................................................... 4,098 c
Discount on notes payable............................. 4,098
b
P40,981 30
c
Interest computed using effective interest method: 10% x P40,981
Entries to correct error:

Building.......................................................... 19,019
Accumulated depreciation: Building.................... 634

Interest expense..................................................... 4,098

Depreciation expense: Building.................... 634
Discount on notes payable............................. 4,098
b. Retained earnings.................................................. 40,000

Cost of goods sold.......................................... 40,000
To correct error from prior year.
Cost of goods sold................................................ 15,000

Inventory........................................................ 15,000
To correct error in current year.

Salaries and wages expense........................... 18,000
To correct error in salary and wage accrual in 2014.
Salaries and wages expense................................... 10,000
Salaries and wages payable............................ 10,000
To accrue salaries and wages at December 31, 2015.
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 2015)............................................................. 14,921
Accumulated depreciation: Building.................... 634
d
Building.......................................................... 19,019
d
Correction of interest expense understatement of P4,098 less
depreciation overstatement of P634
b. The error from 2014 was counterbalanced by the end of 2015, so it can be
ignored.
Inventory........................................................ 15,000
c. The error from 2013 and 2014 were counterbalanced by the end of 2014
and 2015; respectively, so they can be ignored.
Salaries and wages payable............................ 10,000
2013 2014
Reported net income P27,000 P35,000
Subtract ending inventory overstatement (5,000) (2,000)
Add beginning inventory overstatement 5,000
Subtract wages payable when incurred (700) (800)
Add wages payable when expensed 700
Subtract bad debts (1,300) (400)*
Add back prepayments in year recorded as expense 500 200
Subtract prepayments in year expense is incurred (500)
Correct net income P20,500 P37,200
* The effect on income is only P400 because no
accounts were written off during 2014.
Requirement 2
2015
Jan. 1 Retained earnings 4,300
Prepaid expense 200
Inventory 2,000
Wages payable 800
Allowance for doubtful accounts 1,700
(1) Allowance for uncollectible accounts................... 10,000
Administrative expenses................................ 10,000
To reflect reduction in loss experience rate.
(2) (a) Allowance for change in value of AFS
securities...................................................... 3,000
Unrealized holding gain (loss) on
AFS securities (equity)........................ 3,000
(b) Unrealized decline in value of securities-
available-for-sale (equity)........................... 19,000
Allowance for change in value of
AFS securities...................................... 19,000
To reduce securities-available-for-sale to
market valuation.
(3) Retained earnings.................................................. 4,000
Cost of sales.......................................................... 2,100
Merchandise inventory................................... 6,100
To adjust for overstatements in opening

and closing inventories.
(4) Equipment............................................................. 12,000
Operating expenses............................................... 1,100
Accumulated depreciation: Equipment......... 2,200
To adjust for misposting of equipment
purchase in 2014.
(5) Accumulated depreciation: Equipment................ 17,500
Equipment...................................................... 15,000
Other income.................................................. 2,500
To adjust for misposting of equipment sale.
(6) Prepaid expenses................................................... 900
Operating expenses............................................... 900
To adjust for nonrecognition of prepaid
expense in 2014.
(7) Ordinary shares..................................................... 60,000
Capital in excess of par.................................. 60,000
To adjust for capital contributed in
excess of par value.
Requirement 2
Eagle Corporation
Computation of Corrected Net Income
For Years Ended December 31, 2015 and 2014
2015 2014
Debit Debit
(Credit) (Credit)
Reported income P(220,000) P(195,000)
Change in accounts receivable loss
experience rate from 2% to 1% (10,000)
Ending merchandise inventories overstated:
December 31, 2014 (4,000) 4,000
December 31, 2015 6,100
Misposting of equipment purchase:
Decrease in operating expenses (10,900)
2014
Increase in operating expenses 1,100
2015
Misposting of proceeds of equipment sold (2,500)
Recognition of prepaid insurance 900 (1,800)

Corrected net income P(228,400) P(203,700)
P35-10. a. Truck..................................................................... 40,000

b. 2013: P8,000 (P40,000 / 5)

2014: P8,000
P35-11. 2013 2014

Reported net income........................................ P 90,000 P 95,000
2013 overstated ending inventory.................... (8,000) 8,000
..................................................................
2014 overstated ending inventory.................... (5,000)
2013 insurance expense overstated.................. 16,000
2014 insurance expense understated................ (4,000)
2013 understated depreciation expense........... (12,000)
2013 overstated expense on building............... 22,500
2014 understated depreciation expense on
building (2,500)
..................................................................
2013 understated wages expense..................... (7,000)
2014 overstated wages expense....................... 7,000
Corrected net income....................................... P101,500 P 98,500

P35-12. Correcting Entries:
a. Truck..................................................................... 20,000
Depreciation expense [(P20,000 2,000) / 8]....... 2,250
Accumulated depreciation (P2,250 x 3)......... 6,750
b. Interest expense..................................................... 1,503

Machinery...................................................... 6,340
Clients Entry:
January 1, 2013
Machinery.............................................................. 20,000
Notes payable................................................. 20,000
Correct Entries:
2013
Jan. 1 Machinery 13,660
Discount on note payable 6,340
Note payable 20,000
Dec. 31 Interest expense 1,366

Discount on note payable
[0.10 (P13,660] 1,366
2014
Dec. 31 Interest expense 1,503
Discount on note payable
[0.10 (P13,660 + P1,366)] 1,503
P35-13. a. + c. e. + g. + i. +
b. + d. + f. + h. j. +
Multiple Choice Questions
MC35-1. A MC35-16. B MC35-31. B MC35-46. A

2. A 17. C 32. C 47. D
3. C 18. B 33. A 48. C
4. A 19. A 34. A 49. A
5. D 20. A 35. B 50. C
6. A 21. D 36. A 51. B
7. C 22. C 37. D 52. A
8. C 23. B 38. A 53. B
9. D 24. A 39. B 54. C
10. D 25. C 40. D 55. B
11. C 26. C 41. D 56. C
12. C 27. B 42. B 57. B
13. C 28. C 43. A 58. D
14. A 29. D 44. A 59. C

15. C 30. B 45. C 60. D

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Chapter 35

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CHAPTER 35

Additional Aspects of Financial Reporting

Q35-1. a. A change in principle a different generally accepted accounting

Q35-3. An accounting change involves a change in accounting (a) principle, (b)

warranty costs because of a newly discovered defect, a change in the estimated

Q35-8. A counterbalancing (self-correcting) error results from failure to properly

Q35-13. If discovery occurs in 2015, a prior period adjustment is recognized to correct

Q35-15. Effect of Error On

Q35-16. A change in accounting principle occurs when one generally accepted

Q35-18. PAS 34 defines the principles to be followed in reporting accounting changes

E35-1. The cited items are reported as follows:

1. Change in accounting principle; exception to general rule; prior period

E35-2. The cited items are reported as follows:

4. Change in accounting estimate; general rule; charge to income in current

Pro forma amounts assuming the new cost

Earnings per ordinary share P4.90 P3.89

Earnings per share (15,000 shares) P8.17 P7.28

Beginning unadjusted retained earnings P105,000 a P 0

E35-5. 1. Purchases............................................................... 10,000

Retained earnings.................................................. 400

4. Rent expense......................................................... 4,000

5. If discovered during the following year:

6. Retained earnings.................................................. 11,000

Discount on note receivable.................................. 10,000 b

To correct interest revenue in the first year.

E35-6. Assets Liabilities Owners Equity Net Income

Revenue received in advance (unearned):

Alternatively, the following compound journal entry could be made (assuming

Retained earnings........................................... 1,100

Alternatively, the following compound journal entry could be made (assuming

January 1, 2015 (year of change) To record the catch-up adjustment:

Comparative statement of profit or loss and

Earnings per share (10,000 shares). . . P9.40 P9.00

E35-11. Accounting treatment for the cited events:

E35-12. 1. Retained earnings.................................................. 6,300

a. Prior period adjustment correction

b. December 31, 2014 To correct all accounts affected by the discount on

LT investment bonds (P200 x 3 yrs.)..................... 600

c. The 2014 beginning inventory (periodic system) is overstated by P7,000.

b. To correct the error in 2014 income due to the understatement of 2014

Accounts payable were understated in 2014 but are correct in 2015

d. To correct the error in 2014 income, due to the understatement of selling

e. To correct the error in 2014 income because of the understatement of

Although wages payable was understated at the end of 2014, it is correct

f. To correct the understatement of 2014 income because 2014 insurance

Prepaid insurance at the end of 2015 is correct should be zero.

g. To correct the overstatement of 2014 income due to income tax expense

Income tax expense, 2015.............................. 2,400

h. To correct the overstatement of 2014 income due to the failure to record

Error in statement of profit

* Closed to retained earnings.

Comparative statement of financial position:

Retained earnings statement:

Comparative statement of profit or loss and

Note 6: Correction of accounting error During 2014 it was discovered that

2015 Depreciation before accounting change:

2015 Depreciation after accounting change:

2015 entry to record depreciation:

December 31, 2015 Accumulated depreciation balance:

Income on a per share basis: P0.074 P0.095

This is a change in accounting estimate and should be accounted for by using

b. To record SL depreciation for 2014:

Net book value, 1.1.05 P34,000

Comparative statement of financial position,