CHAPTER 10

Accounting Policies, Changes in Accounting Estimates and Errors

Problem 10-1
Change in Accounting Estimate

On January 4, 2009, Guyana, INC. purchased computer hardware for

P600,000/ On the date of acquisition, Guyana’s management
estimated that the computers would have an estimated useful life
of 5 years and would have a residual value of P60,000. The company
used the double-declning-balance method to depreciate the computer
hardware.

In January 2010, Guyana’s management realized that technological

advancements had made the computer virtually obsolete and that
they would have to be replaced. Management decided to change the
estimated useful life of the computer hardware to 2 years.

1. How much depreciation on computer hardware should be recorded

in 2010?
A. P144,000 C. P300,000
B. P120,000 D. P360,000

Solution 10-1

Cost of computer hardware P360,000

Less: Accumulated depreciation, Dec 31, 2009
(P600,000 x 40%) 240,000
Book value, Jan 1, 2010 360,000
Less: Salvage value 60,000
Depreciation for 2010 P300,000

Answer: C

With the revision in estimated useful life, the double-declining-

balance rate is 100% (1/2 x 2) and the depreciation is P360,000
(P360,000 book value x 100%). However, if P360,000 depreciation
would recognized in 2010, the resulting book value would fall
below the estimated residual value. Therefore, the maximum amount
of depreciation for 2010 should be P300,000 (P360,000 book value
on Jan. 1, 2010, minus P60,000 estimate salvage value).

Problem 10-2
Changes in Accounting Estimates

TONGA COMPANY decided on January 2, 2010, to review its accounting

practices. It is due to economic conditions and to make its
financial statements more comparable to those of other companies
in its industry.

The following changes will be effective as of January 1, 2010:

1. Tonga decided to change its allowance for bad debts from 2%

to 4% of its outstanding receivables balance at December 31,
2010 was P690,000. Allowance for bad debts had a debit
balance of P2,000 before adjustment.

2. Tonga decided to use the straight-line method of depreciation

o its equipment instead of the sum-of-the-years’-digits
method. It was also decided that this asset has 10 more years
of useful life as of January 2, 2010. The equipment was
purchased on January 1, 2000, at a cost of P1,100,000. On the
acquisition date, it was estimated that the equipment would
have a 15-year useful life with no residual value.

1. The entry to record the current year provision for bad debt
is

A. Bad debt expense 29,600

Allowance for bad debts 29,600
B. Allowance for bad debts 29,600
Bad debts expense 29,600
C. Bad debt expense 25,600
Allowance for bad debts 25,600
D. Allowance for bad debts 25,600
Bad debts expense 25,600

2. What is the amount of depreciation on equipment for the

current year?
A. P45,833 C. P13,750
B. P9,167 D. P32,083

Solution 10-2

1. Bad debt expense 29,600

Allowance for Bad debt 29,600
Required allowance (690,000 x 4%) P27,600
Add: debit balance for allowance 2,000
Adjustment – increase in allowance P29,600

Answer: A

2. Cost of equipment P1,100,000

Less: Accumulated depreciation, Dec. 31, 2009
 (see computation beelow) 962,500
Book value, Jan. 1, 2010 P137,500
Divide by revised remaining life / 10 yrs
Revised annual depreciation P13,750

Answer: C

COMPUTATION OF DEPRECIATION EXPENSE – SYD METHOD

YEAR Depreciable Cost Fraction Depreciation

2000 P1,000,000 x 15/120 = P137,500
2001 1,000,000 x 14/120 = 128,333
2002 1,000,000 x 13/120 = 119,167
2003 1,000,000 x 12/120 = 110,000
2004 1,000,000 x 11/120 = 100,833
2005 1,000,000 x 10/120 = 91,667
2006 1,000,000 x 9/120 = 82,500
2007 1,000,000 x 8/120 = 73,333
2008 1,000,000 x 7/120 = 64,167
2009 1,000,000 x 6/120 = 55,000
Total P962,500

SYD = L x (L + 1)/2 = 15 x (15 + 1)/2 = 15 x 8 = 120

Problem 10-3
Change in Accounting Estimate

In the past, PERU COMPANY has depreciated its computer hardware

using the straight-line method. The computer hardware has a 10%
salvage value and an estimate useful life for 5 years. As a result
of the rapid advancement of information technology, management of
Peru has determined that it receives most of the benefits from its
computer facilities in the first few years of ownership. Hence, as
of January 1, 2010, Peru proposes changing to the sum-of-the-
years’-digits method for depreciating its computer hardware. The
following computer purchases were made by Peru at the beginning of
each year.

2007 P90,000
2008 50,000
2009 60,000

1. How much depreciation expense was recorded by Peru in 2007,

2008, and 2009?

2007 2008 2009

 A. P18,000 P28,000 P40,000
B. 36,000 36,000 36,000
C. 16,200 36,000 36,000
D. 16,200 25,200 36,000

2. The amount of depreciation expense that should be recognized

in 2010 is
A. P21,240 C. P52,380
B. P63,280 D. P34,200
3. What journal entry, if any, should be prepared on January 1,
2010, to adjust the accounts?
A. Retained earnings 32,400
Accumulated depreciation 32,400
B. Accumulated depreciation 32,400
Retained earnings 32,400
C. Depreciation expense 32,400
Accumulated depreciation 32,400
D. No entry is necessary

Solution 10-3

1. COMPUTATION IF DEPRECIATION –STRAIGHT-LINE METHOD

Depreciation expense
Computer acquisitions: 2007 2008 2009 Total
2007 (P90,000x90% /5) P16,200 16,200 16,200 P48,600
2008 (P50,000x90% /5) 9,000 9,000 18,000
2009 (P60,000x90% /5) 10,800 10,800
Total P16,200 P25,200 P36,000 P77,400

Answer: D

2. COMPUTATION IF DEPRECIATION –SYD METHOD

2007 acquisition:
Cost P90,000
Less: accum. depreciation, Dec31,2009
(P16,200 x 3) 48,600
Book value, Jan.1, 2010 41,400
Less: Salvage value (10% x P90,000) 9,000

Remaining depreciable cost 32,400

SYD rate x 2/3 P21,600

2008 acquisition:
Cost P50,000
Less: accum. depreciation, Dec31,2009
 (P9,000 x23) 18,000
Book value, Jan.1, 2010 32,000
Less: Salvage value (10% x P50,000) 5,000

Remaining depreciable cost 27,000

SYD rate x 3/6 P13,500

2009 acquisition:
Cost P60,000
Less: accum. depreciation, Dec31,2009
(P9,000 x23) 10,800
Book value, Jan.1, 2010 49,200
Less: Salvage value (10% x P60,000) 6,000

Remaining depreciable cost 43,200

SYD rate x 1/10 17,280
P52,380

Answer: C

Computation of SYD rate:

SYD = (L x L+1)/2

Remaining Life
at Dec. 31, 2009 SYD SYD rate
2007 acquisition 2 years 3 2/3
2008 acquisition 3 years 6 3/6
2009 acquisition 4 years 10 4/10

3. No journal entry is necessary. The change in depreciation

method is now accounted for a change in accounting estimate.
Therefore, that change must be handled currently and
prospectively.

PAS 8 provides that the effect of a change in accounting

estimate shall be recognized prospectively by including it in
profit or loss in:

a) the period shall change , if the period affects that

period only, or
b) the period of the change and future periods, if the
change affects both.

The standard further provides the prospective recognition of the

effect of a change in accounting estimate means that the change is
applied to transactions, other events and conditions from the date
of the change in estimate.

Answer: D

Problem 10-4
Change in Accounting Estimate

On January 1, 2010, management of TULAVU COMPANY decided to make a

revision in the estimates associated with its production
equipment. The equipment was acquired on January 3, 2008, for
P800,000 and that had been depreciated using straight –line
method. At the date of acquisition, it had an estimated useful
life of 10 years with an estimated salvage value of P50,000.
Management determined that the equipment’s remaining useful life
is 4 years and that it has an estimated residual value of P60,000.

1. What is the annual depreciation expense recognized in 2008

and 2009?
A. P80,000 C. P74,000
B. P75,000 D. P125,000

2. What is the amount of depreciation expense that should be

recognized in 2010 as a result of the change in estimates?
A. P147,500 C. P125,000
B. P75,000 D. P150,000

Solution 10-4

1. DEPRECIATION EXPENSE FOR 2008 AND 2009

Cost of equipment P800,000
Less: Salvage value 50,000
Depreciable cost P750,000
Divide by estimated useful life / 10 yrs.
Annual depreciation P 75,000

Answer: B

2. REVISED ANNUAL DEPRECIATION

Cost of equipment P800,000
Less: Accumulated depreciation,
Dec. 31,2009 (P75,000 x2) 150,000
Book value, Jan.1, 2010 650,000
Less: Salvage value 60,000
 Remaining depreciable cost 590,000
Divide by revised useful life / 4 yrs.
Revised annual depreciation P147,500

Answer: A

Problem 10-5
Change in Accounting Estimate

EQUADOR CORP. was organized on January 1, 2007. An analysis of the

company’s allowance for bad debts account reveals the following:

Estimated Bad Debts Actual Bad Debts

2007 P15,000 P3,000
2008 26,000 5,000
2009 35,000 9,500
2010 No provisions yet 8,000

In the past, bad debts had been estimated at 3% of credit sales.

The Ecuador Corp.’s accountant has determined that the 3% rate is
in appropriate and suggested that it be revised downward to 1%.
Credit sales for the year ended December 31, 2010, totaled
P950,000.

1. Prepare the entry to record bed debt expense for the year.

2. What adjusting entry, if any, would be made to correct the

inaccurate estimates for prior periods?

Solution 10-5

1. Bad debt expense 9500

Allowance for bad debts (P950,000 x 1%) 9,500

2. No adjusting journal is necessary. The change in bad debt

rate is a change in accounting estimate. The change shall be
accounted prospectively.

Problem 10-6
Change in Accounting Estimate

On January 1, 2007, COLUMBIA, INC. purchased an equipment for

P650,000. The machine had an estimated useful life of 8 years
(with no residual value) at the acquisition date. On January 1,
2010, Columbia determined, as a result of additional information,
that the equipment had an estimated useful life of 10 years from
the acquisition date with no residual value.
 1. Prepare the journal entry, if any, to record the cumulative
effect of the change on prior years.

2. What is the amount of depreciation expense on the equipment

for the year ended December 31, 2010?
A. P65,000 C. P40,625
B. P92,850 D. P58,036

Solution 10-6

1. No adjusting journal is necessary. The change in the

estimated useful life of the equipment is a change in
accounting estimate. A change in accounting estimate should
be reflected currently and prospectively, if necessary. Also,
there should be no restatement of amounts reported in
financial statements of prior periods.

2. Cost of equipment P650,000

Less: accum. depreciation,
Dec. 31, 2009 (P65,000 x 3/8) 243,000
Book value, Jan.1, 2010 406,250
Divide by revised life (10-3) / 74 yrs.
Revised annual depreciation P 58,036

Answer: D

Problem 10-7
Change in Accounting Estimates and Prior Period Errors

The following information pertains to VANATU COMPANY’S depreciable

assets:

1. Machine X was purchased for P150,000 on January 1, 2005. The

entire cost was expensed in the year of acquisition. The
estimated useful life of this machine is 15 years with no
residual value.

2. Machine Y cost P525,000 and was acquired on January 1, 2006.

On the acquisition date, the expected useful life was 12
years with no residual value. The straight-line depreciation
method was used. On January 2, 2010, it was estimated that
the remaining life of the asset would be 4 years and that
there would be a P25,000 residual value.
 3. A building was purchase on January 3, 2007, for P3,000,000.
The building was expected to have a useful life with 20 years
with no residual value. The straight-line depreciation method
was used. On January 1, 2010, a change was made to the sum-
of-the-years’-digits method of depreciation. No change was
made to the estimated useful life and residual value of the
building.

1. The adjusting entry on January 1, 2010, relative to machine X

should include a credit to
A. Accumulated depreciation of P60,000
B. Retained earnings of P100,000
C. Machinery of P150,000
D. No adjusting entry is necessary

2. What is the carrying value of machine Y on January 1, 2010?

A. P350,000 C. P306,250
B. P325,000 D. P525,000

3. What is the depreciation expense on machine Y for 2010?

A. P87,500 C. P81,250
B. P77,083 D. P41,667

4. What is the book value of the building at December 31, 2009?

A. P2,185,714 C. P1,942,857
C. P2,550,000 D. P2,266,667

5. What is the book value of the building at December 31, 2010?

A. P2,185,714 C. P1,942,857
B. P2,550,000 D. P2,266,667

Solution 10-7

1. Machinery X P150,000
Accumulated depreciation – Machinery
(P150,000 x 5*/15) 50,000
Retained earnings (P150,000 - P50,000) 100,000
*Jan. 1, 2005-Dec.1,2009

Answer: B

2. Cost of machine Y P525,000

Less: Accumulated depreciation, Dec.31,2009
(P525,000 x 4/12) 175,000
Carrying value, Dec.31, 2009 P350,000
 Answer: A

3. Carrying value, Dec.31, 2009 (see no.2) P350,000

Less: Salvage value 25,000
Remaining depreciable cost P325,000
Divide by revised remaining life / 4 yrs.
Depreciation for 2010 P 81,250

Answer: C

4. Cost of building P3,000,000

Less: Accumulated depreciation, Dec.31,2009
(P3,000,000 x 3/20) 450,000
Book value of building,Dec.31, 2009 P2,550,000

Answer: B

5. Book value of building , Dec.31, 2009 (see no.4) P2,550,000

Less: Depreciation for 2010
(P2,550,000 x 17/153*) 283,333
Book value of building , Dec.31, 2010 P2,266,000

SYD = L x(( L+1)/2) = 17 x ((17 + 1)/2) = 17 x 9 = 153

Answer: D

Problem 10-8
Change in Accounting Policy

HONDURAS, INC. has been using the FIFO method of inventory costing
since it began operations in 2009. In 2010, the company decided to
change to the weighted method. The following are the December 31,
inventory balances under each method.

FIFO Weighted Average

2009 P450,000 P560,000
2010 895,000 999,000

Prepare the entry, if any, that should be made to record the

change in inventory costing method. Ignore income tax
considerations.

Solution 10-8

Inventory, January 1, 110,000

 Retained earnings 110,000
(P560,000-P450,000)

Problem 10-9
Analysis of Various Errors

The audited income statement of URUGUAY CO. shows a net income of

P175,000 for the year ended December 31, 2010. Adjustments were
made for the following errors:

1. December 31, 2009, inventory overstated by P22,500.

2. December 31, 2010, inventory understated by P37,500.
3. At P10,000 customer’s deposit received in December 2010, was
credited to sales in 2010. The goods were actually shipped in
January 2011.

What is the adjusted income of Uruguay Co. for the year ended
December 31, 2010?
A. P234,000 C. P170,000
B. P125,000 D. P200,000

Solution 10-9

Unadjusted net income (SQUEEZE) P125,000

December 31, 2009 - overstated 22,500
December 31, 2010 - understated 37,500
Customer’s deposit recognized as sales revenue (10,000)
Adjusted net income P175,000

Answer: B

Problem 10-10
Analysis of Various Errors

The December 31 year-end financial statements of Samoa Company

contained the following errors:

Dec. 31, 2009 Dec. 31, 2010

Ending inventory P48,000 understated P40,500 overstated
Depreciation expense P11,500 understated --------

An insurance premium of P330,000 was prepaid in 2009 covering the

years 2009, 2010, and 2011. The entire amount was charged to
expense in 2009. In addition, on December 31, 2010, a fully
depreciated machinery was sold for P75,000 cash, but he sale was
not recorded until 2011. There were no there errors during 2009
and 2010, and no corrections have been made for any of the errors.
Ignore income tax effects.

1. What is the total effect of the errors of Samoa’s net income?

A. P123,500 overstatement
B. P27,500 overstatement
C. P192,500 overstatement
D. P177,500 overstatement

2. What is the total effect of the errors on the amount of

Samoa’s working capital at December 31, 2010?
A. P75,500 overstatement
B. P40,500 overstatement
C. P225,500 understatement
D. P144,500 understatement

3. What is the total effect of the errors on the balance of

Samoa’s retained earnings at December 31, 2010?
E. P156,000 understatement
F. P87,000 overstatement
G. P133,000 understatement
H. P85,000 understatement

Solution 10-10

1. EFFECT ON ERRORS ON 2010 NET INCOME

Over-(Under)
Statement
Understatement of 2009 ending inventory P 48,000
Overstatement of 2010 ending inventory 40,500
Prepaid insurance charged to expense
in 2009 (P330,000 / 3) 110,000
Unrecorded sale of fully depreciated
machinery in 2010 (75,000)
Total effect of errors on net income P123,500

Answer: A

2. EFFECT ON ERRORS ON WORKING CAPITAL AT DEC.31, 2010

Over- (Under)
Statement
Overstatement of 2010 ending inventory P40,500
 Prepaid insurance charged to expense
in 2009 (110,000)
Unrecorded sale of fully depreciated
machinery in 2010 (75,000)
Total effect of working capital P144,500

Answer: D

3. EFFECT ON ERRORS ON RETAINED EARNINGS AT DEC.31, 2010

Over- (Under)
Statement
Overstatement of 2010 ending inventory P40,500
Understatement of depreciation expense in 2009 11,500
Prepaid insurance charged to expense
in 2009 110,000
Unrecorded sale of fully depreciated
machinery in 2010 (75,000)
Total effect on retained earnings P133,000

Answer: C

Problem 10-11
Analysis and Correction of Various Errors

The first audit of the financial statement of KIRIBATI CO. was

made for the year ended in December 31, 2010. In reviewing the
books, the auditor found out that certain adjustments had been
overlooked at the end of 2009 and 2010. He also discovered that
other items had been improperly recorded. These omissions and
other failures for each year are summarized as follows:

December 31
2009 2010
Salaries payable 145,600 130,000
Interest receivable 43,200 35,500
Prepaid insurance 64,000 51,300
Advances from customers(1) 78,400 93,500
Equipment(2) 94,000 87,000

(1) Collections from customers had been recorded as sales

but should have been recognized as advances from
customers because the goods were not shipped until the
following year.
(2) Capital expenditures had been recorded as repairs but
should have been charged to equipment; the depreciation
 rate is 10% per year, but depreciation in the year of
expenditure is to be recognized at 5%.

Assuming that the nominal accounts for 2010 have not been closed
into the income summary account, prepare all the necessary
adjusting journal entries on December 31, 2010.

Solution 10-11

ADJUSTING JOURNAL ENTRIES

December 31, 2010

1. Retained earnings 145,600

Salaries expense 15,600
Salaries payable 130,000

2. Interest receivable 35,000

Interest income 7,700
Retained earnings 43,200

3. Prepaid insurance 52,300

Insurance expense 12,700
Retained earnings 64,000

4. Sales 15,100
Retained earnings 74,400
Advances for customers 93,500

5. Equipment (P94,000+P87,000) 181,000

Depreciation expense (P9,400+4,350) 13,750
Accumulated depreciation – Equipment 18,450
Repairs expense 87,000
Retained earnings (P94,000+4,700) 89,300

Computation of depreciation:
2009 P94,000 x 5% = P4,700
2010 P94,000 x 5% = 9,400
P87,000 x 5% = 4,350
Total P18,450

Problem 10-12
Analysis and Correction of Various Errors

The retained earnings account of Antigua corp. is reproduced

below:
 Retained Earnings

Date Item Debit Credit

2008
Jan.1 Balance P81,000
Dec31 Net income for year 18,000
2009
Jan 10 Dividends prepaid P15,000
Mar 6 Stock sold –excess over par 32,000
Dec 31 Net loss for year 11,200
2010
Jan 9 Dividends paid 15,000
Dec 31 Balance 89,800 _______
P131,000 P131,000

The audit of the December 31, 2010, financial statements of the

company reveals the following:

a. Dividends declared min December 10,2008 and 2009 had not

been recorded in the books until paid.

b. Improvements in building and equipment of P9,600 had

been charged to expense at the end of April 2007.
Improvements are estimated to have an 8-year life.
Antigua 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 2008, and by P4,300
at the end of 2009.

d. Merchandise in transit and to which the company had

title at December 31,2009 and 2010 was not included in
the year-end inventories. These shipments of P3,800 and
P5,500 were recorded as purchases on January of 2010 and
2011 respectively.

e. The company had failed to record sales commissions

payable of P2,100 and P1,700 at the end of 2009 and
2010, respectively.

f. The company had failed to recognize supplies on hand of

P1,200 and P2,500 at the end of 2009 and 2010
respectively.
 g. The company reported a net loss of P12,400 for the year
ended December 31, 2010.

1. Prepare the necessary adjusting journal entries at December

31, 2010.

2. What is the correct net loss of Antigua corp. for the year
ended December 31, 2010?
A. P7,600 C. P6,000
B. P17,000 D. P16,200

Solution 10-12

ADJUSTING JOURNAL ENTRIES

December 31, 2010
1. 1. Building and equipment 9,600
Depreciation expense (P9,600x1/8) 1,200
Accumulated depreciation
(P9,600/8x3 8/12) 4,400
Retained earnings 6,400

2. Cost sales 4,300

Retained earnings 4,300

3. Inventory, Dec.31, 2010 5,500

Accounts payable 5,500

4. Retained earnings 2,100

Sales commission expense 2,100

5. Sales commission expense 1,700

Sales commission payable 1,700

6. Supplied expense 1,200

Retained earnings 1,200

7. Supplies on hand 2,500

Retained earnings 2,500

8. Retained earnings 32,000

Share premium 32,000

2. COMPUTATION OF COORECTED NET INCOME (LOSS)

Prepared net income (loss) P(12,400)
Omission of depreciation (1,200)
 Understatement of physical inventory at Dec. 31, 2009 (4,300)
Overstatement of sales commissions expense
(P2,100-P1,700) 400
Overstatement of supplies expense (P2,500-P1,200) 1,300
Corrected net income (loss) P(16,200)

Answer: D

Problem 10-13
Analysis and Correction of Various Errors

NAURO CO. reported the following for the first two years of
operations:

2008 - P735,000 net income

2009 - P925,000 net income

Early in 2010, the following errors were discovered:

1. Depreciation of building for 2008 was overstated by P85,000.
2. Depreciation of building for 2009 was understated by
P192,500.
3. December 31, 2008, inventory was understated by P250,000.
4. December 31, 2009, inventory was overstated by P81,000.

Prepare the necessary adjusting journal entries. Assume that the

books are closed. Ignore income tax considerations.

Solution 10-13

ADJUSTING JOURNAL ENTRIES

2010

1. Accumulated depreciation – Buildings 85,000

Retained earnings 85,000

2. Retained earnings 192,500

Accumulated depreciation – Buildings 192,500

3. No adjusting journal entry is necessary for the December 31,

2008, inventory understatement. It is a counter-balancing
error.

4. Retained earnings 81,000

Inventory 81,000
Problem 10-14
Analysis and Correction of Various Errors

The following selected accounts are included in the total balance

of PALAU CORP, on December 31, 2010:

Debit Credit
Supplies on hand P135,000
Accrued salaries payable P 75,000
Interest receivable 255,000
Prepaid insurance 4,500,000
Unearned rent
Accrued interest payable 750,000

Additional information is as follows:

1. A physical count of supplies on hand on December 31, 2010,
totaled P55,000.

2. The accountant failed to adjust the Accrued Salaries Payable

account. Accrued salaries payable on December 31, 2010,
totaled P220,000.

3. The Interest Receivable account was also left unadjusted at

December 31, 2010. Accrued receivable on December 31, 2010,
amounted to P217,500.

4. The unexpired portions if the insurance policies totaled

P3,250,000 as of December 31, 2010.

5. A total of P1,400,000 was received on January 1, 2010, for

the rent of a building for both 2010 and 2011.

6. The correct amount of depreciation for the year was

P2,500,000 but was erroneously recorded as P250,000.

7. Prior years’ depreciation was understated by P360,000.

Prepare the necessary adjusting journal entries on December 31,

2010. Assume that the books have not been closed.

Solution 10-14

ADJUSTING JOURNAL ENTRIES

December 31, 2010
 1. Supplies expense 80,000
Supplies on hand 80,000
(P135,000-P55,000)

2. Salaries expense 145,000

Accrued salaries payable 145,000

3. Interest income 37,500

Interest receivable
(P255,000-P217,000) 37,500

4. Prepaid expense 1,250,000

Prepaid insurance 1,250,000

5. Rent income 700,000

Unearned rent
(P1,400,000 / 2) 700,000

6. Depreciation expense 2,250,000

Accumulated depreciation 2,250,000

7. Retained earnings 360,000

Accumulated depreciation 360,000

Problem 10-15
Analysis and Correction of Various Errors

You have been engaged to audit the financial statements of POHPEI

CORP. for the year ended December 31, 2010. Your audit reveals the
following situations:

1. Depreciation of P16,000 for 2010 on equipment was not

recorded.

2. The physical inventory count on December 31, 2010, improperly

excluded merchandise costing P95,000 that had been
temporarily stored in a public warehouse. Pohnpei uses a
periodic inventory system.

3. The physical inventory count on December 31, 2010, improperly

included merchandise with a cost of P42,500 that had been
recorded as sale on December 29,2010, and held for the
customer to pick up on January 2, 20111.

4. A collection of P28,000 on account from a customer received

on December 31, 2010 was not recorded until January 3, 2011.
 5. In 2010, Pohnpei sold for P18,500 fully depreciated equipment
that originally cast P110,000. The proceeds from the sale
were credited to the Equipment account.

6. During December 2010, a competitor company filed a patent-

infringement suit against Pohnpei claiming damages of
P1,000,00. The company’s legal counsel has indicated that an
unfavorable outcome is probable and reasonable estimate of
the court’s award to the competitor is P600,000. The company
has not reflected or disclosed this situation in the
financial statements.

7. Pohnpei has a portfolio of current marketable equity

securities acquired in 2009 for trading purposes. No
valuation entry has been made. Information on cost and market
value is as follows:

Cost Market
December 31, 2009 P475,000 P475,000
December 31, 2010 P475,000 P500,000

8. At December 31,2010, an analysis of payroll information shows

accrued sale salaries of P61,000. The Accrued Salaries
Payable account had a balance of P80,000 at December 31,
2009.

9. A piece of equipment was acquired on January 2, 2010, for

P160,000 and was charged to Repairs expense. The equipment is
expected to have a useful life of 8 years and no residual
value. Pohnpei normally uses the straight-line method to
depreciate this type of equipment.

10. A P75,000 insurance premium paid on July 4, 2009 for a

policy that expires on June 30, 2012, was charged to
Insurance Expense.

11. A patent was acquired at the beginning of 2009 for

P250,000. No amortization gas been recorded since its
acquisition. The patent had a 10-year useful life on the date
of acquisition.

Prepare the necessary adjusting journal entries at December 31,

2010. Ignore income tax considerations.
Solution 10-15

ADJUSTING JOURNAL ENTRIES

December 31, 2010

1. Depreciation expense 16,000

Accumulated depreciation – Equipment 16,000

2. Cost of goods sold (Beginning Inventory) 95,000

Retained earnings 95,000

3. Cost of goods sold 42,500

Inventory 42,500

4. Cash 28,000
Accounts receivable 28,000

5. Accumulated depreciation – Equipment 110,000

Gain on sale of equipment 18,500
Equipment (P110,000-P18,500) 91,500

6. Estimated litigation loss 60,000

Estimated litigation liability 60,000

7. Investment in trading securities 25,000

Unrealized holding gain on trading securities 25,000

Fair value, Dec.31, 2010 P500,000

Fair value, Dec.31, 2009 475,000
Increase in fair value P 25,000

8. Accrued salaries payable 19,000

Salaries expense 19,000
(P80,000-P61,000)

9. Depreciation expense (P160,000 / 8 years) 20,000

Equipment 160,000
Repairs expense 160,000
Accumulated depreciation – Equipment 20,000

10. Insurance expense (P75,000 / 3 years) 25,000

Prepaid insurance (P75,000 / 3 x 1.5) 37,500
Retained earnings (P75,000 – P75,000 x 5/3) 62,500

11. Amortization expense (P250,000 / 10) 25,000

Retained earnings 25,000
Patent 50,000
Problem 10-16
Correcting Net Income

The condensed income statement of SURINAME, INC. for the year

ended December 31, 2010, is presented below:

Suriname, Inc.
INCOME STATEMENT
For the Year Ended December 31, 2010

Sales P1,000,000
Cost of goods sold 600,000
Gross income 400,000
Operating expenses 150,000
Net income P 250,000

The December 31, 2010, audit the company’s financial statements

disclosed the following errors:

1. December 31, 2010, inventory understated P31,000.

2. Accrued expenses of P4,000 and prepaid expenses of P6,000

were not recognized in the company’s books.

3. Sales of P5,000 were not recorded until January 2011,

although the goods were shipped in December 2010, and were
excluded from the December 31, physical inventory.

4. Purchases of P30,000 made in December 2010, were not recorded

although the goods were received and properly included in
the December 31, physical inventory.

5. A machine was sold for P10,000 on July 1, 2010., and the

proceeds were credited to the Sales account. The machine was
acquired on January 1, 2007 for P60,000. At that time, it had
an estimated life of 6 years with no residual value. No
depreciation was recorded on this machine in 2010.

1. Prepare the necessary adjusting journal entries on December

31, 2010.

2. What is the correct net income for the year ended December
31, 2010?
 A. P228,000 C. P258,000
B. P166,000 D. P224,000

Solution 10-16

ADJUSTING JOURNAL ENTRIES

December 31, 2010

1. a. Inventory 31,000
Cost of goods sold 31,000
b. Prepaid expenses 6,000
Operating expenses 2,000
Accrued expenses 4,000

c. Accounts receivable 5,000

Sales 5,000

d. Cost of goods sold (Purchases) 30,000

Accounts payable 30,000

e. Operating expenses (Depreciation) 5,000

Accumulated depreciation 5,000
(P60,000 / 6 x 6/12)
f. Sales 10,000
Accumulated depreciation
(P60,000 / 6 x 3 6/12) 35,000
Loss on sale of machinery 15,000
Machinery 60,000

Cost of machine P60,000

Less: Accumulated depreciation 35,000
Book value P25,000
Proceeds 10,000
Loss on sale P15,000

2. COMPUTATION OF CORRECTED NET INCOME

Reported net income P250,000

AЈE a 31,000
b 2,000
c 5,000
d (30,000)
e 5,000
f (10,000)
 (15,000)
Corrected net income P228,000

Answer: A

Problem 10-17
Correcting Net Income

CHILE CO. reported pretax incomes of P505,000 and P387,000 for the
years ended December 31, 2009 and 2010 respectively. However, the
auditor noted that the following errors had been made:

a. Sales for 2009 included amounts of P191,000 which had been

received in cash during 2009, but for which the related goods
were shipped in 2010. Title did not pass to the buyer until
2010.

b. The inventory on December 31, 2009, was understated by

P43,200.

c. The company’s accountant, in recording interest expense for

both 2009 and 2010 on bonds payable, made the following entry
on an annual basis:

Interest expense 75,000

Cash 75,000

The bonds has a face value of P1,250,000 and pay a nominal;

interest rate of 6%. They were issued at a discount of P75,000 o n
January 1, 2009, to yield an effective interest rate of 7%.

d. Ordinary repairs to equipment had been erroneously charged to

the Equipment account during 2009 and 2010. Repairs of
P42,500 and P47,000 had been incurred in 2009 and 2010
respectively. In determining depreciation charges, Chile
applies a rate of 10% to the balance in the equipment account
at the end of the year.

1. What is the corrected pretax income for 2009?

A. P303,200 C. P311,700
B. P225,300 D. P307,450

2. What is the corrected pretax income for 2010?

C. P488,992 C. P484,292
D. P480,042 D. P575,392
Solution 10-17

1. Corrected pretax income for 2009 P311,700

Answer: C

2. Corrected pretax income for 2010 P488,992

Answer: A

2009 2010
Pretax income P505,000 P387,000
Sales revenue erroneously recognized
in 2009 (191,000) 191,000
Understatement of 2009 ending inventory 43,200 (43,200)
Understatement of bond interest expense (1) (7,250) (7,758)
Ordinary repairs erroneously capitalized (42,500) (47,000)
Overstatement of depreciation(2) 4,250 8,950
Corrected pretax income P311,700 P488,992

(1)
Book Value Nominal Effective Discount
Year of Bonds Interest Interest Amortization
2009 P1,175,000 P75,000 P82,250 P7,250
2010 1,182,250 75,000 82,758 7,758
(2) Overstatement of depreciation
2009 (P42,500 / 10) P4,250
2010 (P42,500 / 10) P4,250
(P47,000 / 10) 4,700 P8,950

Problem 10-18
Correcting Net Income

BARBADOS, INC. has been using the accrual basis of accounting.

However, an examination of the records reveals that some expenses
and revenues have been handled on a cash basis by the
inexperienced bookkeeper in the company. Income statements
prepared by the bookkeeper reported P145,000 net income for 2009
and P185,000 net income for 2010. Further review of the records
reveals that the following items were handled improperly.

1. Rent of P6,500 was received from a lessee on December 23,

2009. It was recorded as income at that time even though the
rental pertains to 2010.
 2. Salaries payable on December 31 have been consistently
omitted from the records of that date and have been recorded
as expenses when paid in the following year. The salary
accruals recorded in this manner were:

December 31, 2008 P5,500

December 31, 2009 7,500
December 31, 2010 4,700

3. Invoices for office supplies purchased have been charged to

expense accounts when received. Inventories of supplies on
hand at the end of each year have been ignored, and no entry
has been made for them.

1. What is the corrected net income for 2009?

A. P133,700 C. P146,700
B. P144,200 D. P139,300

3. What is the corrected net income for 2010?

A.P184,700 C. P185,600
B.P197,700 D. P190,900

Solution 10-18

1. Corrected net income for 2009 P133,700

Answer: A

2. Corrected net income for 2010 P197,700

Answer: B

2009 2010
Reported net income P145,000 P185,000
Unearned rent (6,500) 6,500
Unrecorded salary accruals:
Dec.31, 2008 5,500
Dec.31, 2009 (7,500) 7,500
Dec.31, 2010 (4,700)
Supplies on hand not recognized:
Dec.31, 2008 (6,500)
Dec.31, 2009 3,700 (3,700)
Dec.31, 2010 ______ 7,100
Corrected net income P133,700 P197,700
Problem 10-19
Correction of Errors

SENEGAL, CO. is in the process of obtaining a loan at Metropolis

Bank. The bank has requested audited financial statements.
Senegal’s financial statements have never been audited before. It
has prepared the following comparative financial statements for
the years ended December 31, 2010 and 2009.

Senegal Co
COMPARATIVE STATEMENTS OF FINANCIAL POSITION
December 31, 2010 and 2009

2010 2009
Assets
Current assets:
Cash and Cash equivalents P1,205,000 P 800,000
Accounts receivable 1,960,000 1,480,000
Allowance for bad debts (85,000) (90,000)
Inventory 1,035,000 1,010,000
Total current assets 4,015,000 3,200,000

Non-current assets:
Property, plant and equipment 835,000 847,000
Accumulated depreciation (608,000) (532,000)
Total non-current assets 227,000 315,500
Total assets P4,242,000 P3,515,500

Liabilities and shareholders’ equity

Liabilities:
Accounts payable P 607,000 P 980,500

Shareholders’ equity:
Ordinary shares, P20 par value;
150 shares authorized;
65,000 shares issued and outstanding 1,300,000 1,300,000
Retained earnings 2,335,000 1,235,000
Total shareholders’ equity 3,635,000 2,535,000
Total liabilities and shareholders’ equity P4,242,000 P3,515,500

Senegal Co
COMPARATIVE INCOME STATEMENTS
For the years ended December 31, 2010 and 2009
 2010 2009
Sales P5,000,000 P4,500,000
Cost of goods sold 2,150,000 1,975,000
Gross income 2,850,000 2,525,000
Operating expenses:
Selling expenses 1,150,000 1,025,000
Administrative expenses 600,000 525,000
Total operating expenses 1,750,000 1,550,000
Net income P1,100,000 P 975,000

The 2010 audit revealed the following facts:

a. On January 5, 2009, Senegal 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. Senegal has decided to reduce the
amount of bad debt expense from 2% to 1½% of sales, beginning
with 2010. (A charge of 2% has already been made for 2010.)

c. Senegal uses the periodic inventory system. The following are

the inventory errors for the last 2 years.

2009 – Ending inventory overstated by P75,500

2010 – Ending inventory overstated by P99,000

d. An equipment costing P150,000 was acquired on January 3,

2009. The purchase was recorded by a charge to operating
expense. The equipment ha a useful life of 10 years and a
residual value of P25,000. Senegal uses the straight-line
method in depreciating its assets.

1. Prepare the adjusting journal entries to correct the books at

December 31, 2010. Assume that the books for 2010 have not
been closed.

2. What is Senegal’s corrected net income for the year ended

December 31,2009?
A. P1,012,200 C. P786,800
B. P1,212,800 D. P1,061,800

4. What is Senegal’s corrected net income for the year ended

December 31,2010?
A.P1,095,200 C. P1,082,800
B.P1,129,800 D. P1,107,800
Solution 10-19

ADJUSTING JOURNAL ENTRIES

December 31, 2010

1. a. Prepaid insurance (P31,000 x 3/5) 18,600

Insurance expense (P31,000 x 1/5) 6,200
Retained earnings (P31,000 x 4/5) 6,200
b. Allowance for bad debts 25,000
Bad debts expense 25,000
(2% - 1½% x P5,000,000)
c. Retained earnings 75,500
Cost of goods sold (P99,000 – P75,500) 23,500
Inventory 99,000

d. Equipment 150,000
Depreciation expense
(P125,000 x 1/10) 12,500
Retained earnings (P150,000-P12,000) 137,500
Accumulated depreciation – Equipment 25,000
(P125,000 x 2/10)

2. Corrected net income for 2009 P1,061,800

Answer: D

3. Corrected net income for 2010 P1,082,800

Answer: C

COMPUTATION OF CORRECTED NET INCOME

2010 2009
Reported net income P1,100,000 P 975,000
Prepaid insurance charge to expense (6,200) 24,800
Decrease in bad debts expense rate 25,000
Ending inventory - overstate:
2009 75,000 (75,000)
2010 (99,000)
Cost of machine charged to expense 150,000
Unrecorded depreciation (12,500)
(12,500)
Corrected net income P1,082,800 P1,061,800

Problem 10-20
Correction of Errors
In the course of your examination of the December 31, 2010,
financial statements of TUNISIA COMMPANY, you discovered certain
errors that occurred during 2009 and 2010. No errors were
corrected during 2009. The errors are summarized below:

1. Beginning merchandise inventory (January 1, 2009) was

understated by P259,200.

2. Merchandise costing P72,000 was sold for P120,000 to Naval

Company on December 28, 2009, but the sale was recorded in
2010. The merchandise was shipped FOB shipping point and was
not included in ending inventory. Tunisia uses a periodic
inventory system.

3. A two-year, fire insurance policy was purchased on May 1,

2009 for P172,800. The whole amount was charged to Prepaid
Insurance. No adjusting entry was prepaid in 2009 and 2010.

4. A one-year note receivable of P288,000 was held by Tunisia

beginning October 1, 2009. Payment of the 10% note and
accrued interest was received upon maturity. No adjusting
entry was made on December 31, 2009.

5. Equipment with a 10-year life was purchased on January 1,

2009, for P1,176,000. No depreciation expense was recorded
during 2009 or 2010. Assume that the equipment has no
residual value and that Tunisia uses the straight-line method
for recording depreciation.

Prepare journal entries to correct each of the errors described

above. Assume that the nominal accounts for 2010 have not yet been
closed into the income summary account.

Solution 10-20

ADJUSTING JOURNAL ENTRIES

December 31, 2010

1. No journal entry is necessary. The 2009 beginning inventory

understatement is offset by 2008 ending inventory
understatement. It is a counter-balancing error.

2. Sales P120,000
Retained earnings P120,000
3. Insurance expense (P172,800 x 12/24) 86,400
Retained earnings (P172,800 x 8/24) 57,600
Prepaid insurance 144,000

4. Interest revenue 7,200

Retained earnings 7,200
(P172,800 x 3/12)

5. Depreciation expense (P1,176,000/10) 117,600

Retained earnings (P1,176,000/10) 117,600
Accumulated depreciation – Equipment 235,200