Comprehensive Audit of Balance Sheet and Income Statement Accounts

CHAPTER
COMPREHENSIVE AUDIT OF
BALANCE SHEET AND INCOME
STATEMENT ACCOUNTS
19
19-1.
Daffodil, Inc.
Adjusting Journal Entries
12.31.07
AJE (1)
(2)
Share donation
Treasury shares
Land
Building
35,000
10,000
15,000
Accumulated depreciation - machinery

Loss on sale of machinery
Machinery
Cost
Less: AD (20%)
NBV
Proceeds
Loss
(3)
60,000
(b) Factory operating expenses

Accumulated depreciation - building
Accumulated depreciation - machinery
(4)
3,000
P 5,000
1,000
P 4,000
2,000
P 2,000
(a) Accumulated depreciation - building

Retained earnings
Building (P315,000 x 2%)

Machinery:
5,000 x 10% =
145,000 x 10% =
1,000
2,000
300
300
21,300
6,300
15,000
P 500
14,500
P15,000
Merchandise inventory, 12.31.07 B/S

Merchandise inventory, 12.31.07 I/S
175,000
175,000
19-2
Solutions Manual to Accompany Applied Auditing, 2006 Edition

(5)
(6)
(7)
(8)
(9)
Administrative expenses
Allowance for doubtful accounts
1,000
Factory operating expenses

Unexpired insurance
3,000
Retained earnings
Bond interest expense
Unamortized bond discount
2,500
2,500
Sinking fund assets

First Mortgage SF Bonds
Sinking fund assets
Sinking fund income
1,000
3,000
5,000
23,500
23,500
1,500
1,500
Comprehensive Audit of Balance Sheet and Income Statement Accounts

19-1.
Daffodil, Inc. (continued)
Cash
Accounts receivable
Provision for doubtful accounts
Inventories, 12.31.06
Unexpired insurance, 12.31.06
Land
Buildings
Accumulated Depreciation - Buildings
Machinery
Accumulated Depreciation - Machinery
Sinking fund assets
Unamortized bond discount
Treasury shares, ordinary
Accounts payable
Bond interest accrued
1st Mortgage, 6% SF Bonds
Ordinary shares
Premium on ordinary shares
Share donation
Retained earnings, 12.31.06
Sales
Purchases
Payroll
Factory operating expenses
Administrative expenses
Bond interest expense
Loss on sale of machinery
Merchandise inventory 12.31.07
Sinking fund income
Daffodil, Inc.
Working Trial Balance
12.31.07
Trial Balance
Dr
Cr
P 64,000
200,000
P 1,000
223,000
6,000
220,000
330,000
6,600
148,000
15,000
25,000
Adjustments
Dr
283,500
169,000
121,500
1,000
(6)
(1)
(1)
(3b)
(2)
(3b)
3,000
10,000
15,000
6,300
3,000
15,000
(3a)
(2)
(8)
(9)
300
1,000
23,500
1,500
(7)
(1)
5,000
35,000
(8)
23,500
(1)
(7)
60,000
2,500
(3a)
3,000
210,000
315,000
12,600
145,000
29,000
50,000
20,000
88,000
3,750
250,000
500,000
50,000
71,950
300
P 875,000
283,500
169,000
35,000
15,000
P1,900,000
(5)
Balance Sheet
Dr
Cr
P 64,000
200,000
P 2,000
P 223,000
25,000
35,000
88,000
3,750
226,500
500,000
50,000
60,000
74,150
875,000
Income Statement
Dr
Cr
Cr
(3b)
(6)
(5)
21,300
3,000
1,000
145,800
36,000
(7)
2,500
17,500
(2)
(4)
2,000
175,000
P1,900,000
P 293,600
Net Income
19-3
2,000
(4)
(9)
175,000
1,500
P 293,600
175,000
1,500
175,000
P 876,800
174,700
P1,051,500
P1,182,000
P1,007,300
174,700
P1,051,500
P1,051,500
P1,182,000
P1,182,000
19-4
19-2.
Part I
Adjusting Journal Entries, 12-31-05
AJE (1)
Depreciation expense
Accumulated depreciation
1,778
1,778
[(P22,000 P2,000) P4,000]

9
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Prepaid interest
Retained earnings
Interest expense
Merchandise inventory, 12-31-07, BS
Merchandise inventory, 12-31-07, IS or
Cost of Sales
3,100
1,900
15,000
15,000
Retained Earnings
Purchases
6,000
Prepaid insurance
Insurance expense
3,000
Store supplies inventory

Store supplies expense
Retained earnings
1,450
6,000
3,000
550
900
Retained earnings
Commissions expense
Accrued commissions payable
730
240
Cash in bank
Miscellaneous income
650
Purchases
Accounts payable
800
(10) Income from Investment

Investment
(11) Prepaid advertising and promotions
Advertising and promotions expense
(12)
5,000
970
650
800
3,000
3,000
90,000
90,000
NO AJE
(13) Machinery
Depreciation expense machinery
Allowance for depreciation machinery
Repairs and maintenance
20,000
167
167
20,000

(14) Miscellaneous income
Gain on sale of treasury shares
Land
Additional paid-in capital arising from
Treasury Share transactions
2,000
5,000
(15) Doubtful accounts expense

Allowance for uncollectible accounts
14,500
Required allowance as of 12-31-07

on past due accounts (5% x P30,000)
on current accounts (1% x P400,000)
Total
Unadjusted debit balance of the Allowance
account
Additional Provision
19-5
2,000
5,000
14,500
P 1,500
4,000
P 5,500
9,000
P14,500
Part II Column B Adjustment, 12-31-07

AJE (a)
Retained earnings
Purchases
xx
(b)
NONE
xx
(c)
Retained Earnings
Allowance for depreciation
xx
Retained Earnings
xx
Machinery
Retained earnings
xx
Depreciation
xx
Retained earnings
Taxes
xx
xx
xx
(d)
(e)
(f)
(g)
19-3.
xx
xx
xx
xx
xx
International Company
AJE (1)
(2)
Accumulated depreciation delivery vehicle
Cost of sales
Retained earnings
3,200
3,200
19,000
19,000
19-6

(3)
(4)
(5)
(6)
(7)
(8)
(9)
Cost of sales
Inventory
8,500
Cash
Accounts receivable
5,600
Accumulated depreciation equipment

Equipment
Gain on sale of equipment
Estimated litigation loss
Estimated litigation liability
8,500
5,600
22,000
18,300
3,700
125,000
125,000
Unrealized holding gain or loss Income

Allowance for decline in value of securities
2,000
Accrued salaries payable

Salaries expense
3,800
Equipment
Repairs expense
(10) Insurance expense

Prepaid insurance
Retained earnings
2,000
3,800
4,000
32,000
32,000
4,000
5,000
7,000
12,500
(11) No adjusting entry. Trademark has indefinite

life and no amortization need be made.
19-4.
Sunshine Cosmetics, Inc.

Requirement (1)
AJE (1)
(2)
(3)
Inventory, Dec. 31, 2006 (BS)

Inventory, Dec. 31, 2006 (IS) or
Cost of sales
67,200
Doubtful accounts expense

(15,660 740)
14,920
Accounts payable
Purchase returns and allowances
20,760
67,200
14,920
20,760

(4)
(5)
(6)
(7)
(8)
(9)
Sales commissions
Accrued commissions payable
19-7
216
216
Freight-in
Accounts payable
1,600
Advertising expense
Prepaid advertising
1,212
Freight-out or Expense
Sales
8,400
Interest receivable
Interest income
1,380
1,300
1,600
1,212
8,400
1,380
1,300
(10) Supplies expense

Unused Supplies
1,160
1,160
(11) Provision for Income tax expense

Income tax payable
107,386
107,386
Requirement (2)
Income Statement
For the Year Ended December 31, 2006
Revenue from sales:
Sales
Less: Sales returns and
and allowances
Sales discounts
Cost of goods sold:
Inventory, January 1
Net purchases:
Purchases
Less purchase returns
and allowances
Freight-in
Cost of goods available
for sale
Less Inventory, December 31
Gross profit on sales
P998,800 (a)
P 22,400
1,760
24,160
P974,640
P179,400
P346,000
20,760 (c)
325,240
12,650 (b)
P517,290
108,300 (d)
408,990
P565,650
19-8

Other income:
Interest revenue
Dividend revenue
Gain on sale of assets
Total income
Operating expenses:
Selling expenses:
Sales salaries and
commissions
Advertising expense
Sales/delivery equipment
Freight expense
Travel expense sales
representatives
Miscellaneous selling
expenses
General and administrative
expenses:
Legal services
Insurance and licenses
office equipment
Utilities
Telephone and postage
Supplies expense
Officers salaries
Doubtful accounts expense
Total operating expenses
Other expense and losses:
Interest expense
Loss on sale of equipment
Income from continuing
operations before income taxes
Income taxes
Income from continuing
operations
Discontinued operations:
Gain from discontinued
operations (net of income
taxes of P25,600)
Net income
P 2,780 (i)
14,300
37,000
54,080
P619,730
P 70,216 (e)
33,392 (f)
13,500 (g)
8,400
9,120
4,400
P139,028
P 4,450
17,000
9,600
12,800
2,950
1,160 (k)
73,200
14,920 (h)
136,080
(275,108)
P 9,040
45,200
(54,240)
P290,382
92,922 (j)
P197,460
54,400
P251,860

Earnings per ordinary share:
Income from continuing operations (P197,460 78,000 shares)
Gain from discontinued operations (P54,400 78,000 shares)
Net income (P251,860 78,000 shares)
19-9
P2.53
0.70
P3.23
Computations:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
Sales: P990,400 + P8,400 = P998,800

Freight-in: P11,050 + P1,600 = P12,650
Purchase returns and allowances: P346,000 x 6% = P20,760
Inventory: P41,100 + P67,200 = P108,300
Sales salaries and commissions: P70,000 + (P7,200 x 3%) = P70,216
Advertising expense: P32,180 + (P3,636 x 2/6) = P33,392
Depreciation expense: P12,200 + (P15,600 x 10/120) = P13,500
Doubtful accounts expense: (P522,000 x 3%) P740 = P14,920
Interest revenue: P1,400 + P1,380 = P2,780
Income taxes: P335,582 x 32% = P107,387
Supplies expense: P4,360 P3,200 = P1,160
Retained Earnings Statement
Retained earnings, January 1

Add net income per income statement
P 881,340
251,860
P1,133,200
66,000
P1,067,200
Deduct dividends paid

Retained earnings, December 31
19-5.
Del Bakery
Working papers are not required, but they facilitate the preparation of a corrected
balance sheet.
Del Bakery
Working Papers for Corrected Balance Sheet
December 31, 2007
Account Title
Current Assets .....................
Current Liabilities .................
Other Assets ........................
Other Liabilities ....................
Investment in Business ........
Balance Sheet
Debit
Credit
53,415
..............
.............
29,000
75,120
..............
.............
3,600
.............
95,935
128,535
128,535
Corrections
Debit
Credit
..............
(a) 53,415
(c) 29,000
.............
..............
(b) 75,120
(d) 3,600
.............
(e) 95,935
.............
..............
.............
Corrected Balance Sheet

Debit
Credit
.............
..............
.............
..............
.............
..............
.............
..............
.............
..............
.............
..............
19-10

Cash .....................................
Investment Securities
trading (at market value) ....
Trade Accounts Receivable.
Inventory...............................
Supplies Inventory................
Delivery Truck ......................
Fixtures.................................
Accumulated Depreciation
Fixtures...............................
Cash Surrender Value of
Insurance on Officers
Lives ...................................
Retained Earnings................
Land .....................................
Buildings...............................
Buildings [2 (P62,000
20)]
11% Mortgage Payable........
11% Mortgage Payable
(current portion)..................
Interest Payable ...................
Trade Accounts Payable......
Miscellaneous Liabilities ......
Share Capital, P5 stated
value, 5,000 shares............
Paid-in Capital from Sale of
Shares at More Than
Stated Value.......................
Corrections:
(a)
(b)
(c)
.............
..............
(a) 10,600
.............
10,600
..............
.............
.............
.............
.............
.............
.............
..............
..............
..............
..............
..............
..............
(a)
(a)
(a)
(a)
(a)
(a)
.............
.............
.............
.............
.............
.............
2,575
12,500
8,040
425
2,100
12,500
..............
..............
..............
..............
..............
..............
.............
..............
..............
(a) 2,100
.............
2,100
.............
.............
.............
.............
.............
.............
.............
..............
..............
..............
..............
..............
..............
..............
(a) 4,100
(a) 2,675
(b) 7,750
(d)
350
..............
(b) 30,000
(b) 62,000
.............
.............
.............
.............
(e) 40,935
.............
.............
4,100
.............
.............
.............
.............
30,000
62,000
..............
..............
..............
30,160
..............
..............
..............
.............
.............
..............
..............
..............
..............
(b) 7,750
(b) 12,000
.............
.............
7,750
12,000
.............
.............
.............
.............
..............
..............
..............
..............
..............
..............
..............
..............
(b) 4,000
(b)
880
(c) 29,000
(d) 3,950
.............
.............
.............
.............
4,000
880
29,000
3,950
.............
..............
..............
(e) 25,000
.............
25,000
.............
..............
..............
284,150
(e) 30,000
284,150
.............
144,840
30,000
144,840
To restate current assets

To restate other assets
To restate current liabilities
2,575
12,500
8,040
425
2,100
12,500
(d)
(e)
To restate other liabilities

To restate owners equity accounts
Del Bakery
Corrected Balance Sheet
December 31, 2007
Assets
Current assets:
Cash ........................................................................
Investment securities trading (reported at
market; cost P4,250) .........................................
Trade accounts receivable (fully collectible)..........
Inventory.................................................................
Supplies inventory ..................................................
P10,600
2,575
12,500
8,040
425
P 34,140

Investments:
Cash surrender value of life insurance....................
Land, buildings and equipment:
Land........................................................................
Buildings.................................................. P62,000
Less accumulated depreciation ..........
7,750
Fixtures .................................................... P12,500
Less accumulated depreciation ..........
2,100
Delivery truck.........................................................
Total assets ...................................................................
Liabilities
Current liabilities:
Mortgage payable, portion due this year ................
Accounts payable....................................................
Interest payable.......................................................
Miscellaneous accrued liabilities ............................
11% Mortgage payable (noncurrent portion) ...............
Total liabilities..............................................................
Owners Equity
Contributed capital:
Share capital, P5 stated value,
5,000 shares ....................................... P25,000
Paid-in capital from sale of
ordinary shares at more than
stated value ........................................ 30,000
Retained earnings .........................................................
Total owners equity.....................................................
Total liabilities and owners equity ..............................
19-6.
19-11
4,100
P30,000
54,250
10,400
2,100
P 4,000
29,000
880
3,950
96,750
P134,990
P 37,830
12,000
P 49,830
P55,000
30,160
85,160
P134,990
Masipag Corporation
Adjusting Journal Entries, Dec. 31, 2007
AJE (1)
(2)
(3)
Cash
Accounts payable
Accounts receivable
Cash
Bank loan payable
Other expenses
Cash
200,000
200,000
10,000
10,000
400,000
12,500
412,500
19-12

(4)
(5)
(6)
(7)
(8)
(9)
Cash
Accounts receivable
Operating expenses
Cash
Cash
Other income
Accounts receivable others (2,000 + 3,000)
Operating expenses
Cash
75,000
75,000
1,500
1,500
16,000
16,000
5,000
2,000
7,000
Marketable securities
Other income
40,000
Other income
54,000
(10) Marketable securities

Other income
(10.a) Valuation allowance Marketable securities
Trading
Other income Unrealized holding gain
40,000
54,000
32,000
32,000
145,600
145,600
(11) Sales
Accounts receivable
500,000
(12) Inventory
Cost of sales
400,000
500,000
400,000
(13) Accounts receivable others (30,000 15,000)

Accounts receivable
15,000
(14) Accounts receivable others

Accounts receivable
55,000
(15) Accounts receivable

Other current liabilities
50,000
(16) Operating expenses

21,900
(17) Other income

Discount on notes receivable
54,545
(18) Discount on notes receivable

Other income
15,000
55,000
50,000
21,900
54,545
4,545
4,545

(19) Cost of sales
Accounts payable
60,000
(20) Cost of sales

Accounts payable
25,000
(21) Inventory
Cost of sales
25,000

Inventory
16,000
(23) Sales
Accounts receivable
13,000

Prepaid expenses
46,250

Prepaid expenses
5,000
(26) Other assets

Operating expense
Prepaid expenses
60,000
120,000
19-13
60,000
25,000
25,000
16,000
13,000
46,250
5,000
180,000
(27) Long-term bond investment

Other income
5,777

Other income
5,333
5,777
5,333
(29) Land
Building
Land and building
1,062,500
3,187,500
(30) Building
Land and building
425,000

Land and building
20,000

Prepaid expenses
Land and building
27,500
27,500
4,250,000
425,000
20,000
55,000
19-14

(33) Land and building
Operating expenses
Accumulated depreciation building
237,500
115,578
121,922
(34) Prepaid expenses

Operating expenses
Equipment
10,000
10,000

55,400
(36) Accounts payable

50,000

Estimated liability on warranties
15,000
(38) Other current liabilities

Other expenses
50,000
20,000
55,400
50,000
15,000
50,000
(39) Income taxes payable

Provision for income tax
115,290
115,290
MASIPAG CORPORATION
Balance Sheet
December 31, 2007
Assets
Current assets
Cash
Valuation allowance
Accounts receivable
Notes receivable
Discount on notes receivable
Accounts receivable others
Inventory, December 31, 2007
Prepaid expenses
Total current assets
Investments
Long-term bond investment
Property, plant and equipment
Land
Building
Accumulated depreciation Building
P
P 400,000
145,600
P 442,000
(33,150)
P 600,000
(50,000)
734,000
545,600
408,850
550,000
96,333
1,960,500
175,250
P4,470,533
744,077
P1,062,500
P3,612,500
(121,922)
3,490,578

Equipment
Accumulated depreciation Equipment
P1,654,000
(235,400)
19-15
1,418,600
Total property, plant and equipment

Other assets
Total assets
5,971,678
110,000
P11,296,288
Liabilities and Shareholders Equity

Current liabilities
Accounts payable
Bank loan payable
Accrued expenses payable
Income taxes payable
Estimated liability on warranties
Total current liabilities
Shareholders equity
Ordinary shares
Additional paid-in capital
Retained Earnings
Total shareholders equity
Total liabilities and shareholders equity
P 877,000
1,100,000
59,000
100,000
130,558
70,000
P 2,336,558
P5,000,000
1,655,250
2,304,480
8,959,730
P11,296,288
MASIPAG CORPORATION
Income Statement
Sales
Cost of sales
Gross profit
Other income
Operating expenses
Other expenses
Income before taxes
Provision for income tax
Net Income
19-7.
P 6,437,000
(4,060,000)
P 2,377,000
225,710
(1,511,509)
(37,500)
P 1,053,701
(342,441)
P 711,260
Felicity Company
Adjusting Journal Entries, Dec. 31, 2007
AJE (1)
Cash
Prepaid interest
Other charges
Long-term debt (current portion)
Long-term debt
31,000
3,000
2,000
24,000
12,000
19-16

(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Cash
Accounts payable and others
2,000
2,000
Investments in SMC shares available for sale

(non-current)
72,000
Unrealized loss due to decline in value of

non-current investment (equity)
Operating expenses
20,000

Operating expenses
Accounts receivable
Operating expenses
72,000
20,000
41,100
41,100
8,000
8,000
Inventory
Cost of sales
12,000
Sales
Accounts receivable
14,400
Revaluation increment
Property and equipment
12,000
14,400
120,000
80,000
200,000
(10) Accumulated depreciation

Operating expenses
36,000

48,000
(12) Revaluation increment

Retained earnings
24,000
(13) Property and equipment

Operating expenses
30,000
(14) Retained earnings

Cumulative effect of change in accounting
principle
13,000

Cash
22,000
36,000
48,000
24,000
30,000
13,000
22,000

(16) Provision for income tax
Income tax payable
19-17
25,445
25,445
FELICITY COMPANY
Balance Sheet
December 31, 2007
Assets
Current Assets:
Cash............................................................................................
Accounts receivable ...................................................................
Allowance for doubtful accounts ...............................................
Accounts receivable -others .......................................................
Inventories..................................................................................
Prepaid interest...........................................................................
Non-current Assets:
Advances to affiliate ..................................................................
Investments in SMC shares available for sale .........................
Allowance for decline in value of non-current investment ........
Property and equipment .............................................................
Accumulated depreciation..........................................................
Total Assets
123,600
1,751,820
(27,000)
62,000
262,000
3,000
48,000
72,000
(20,000)
2,600,000
(1,172,000)
P 3,703,420
Liabilities and Shareholders Equity

Accounts payable and others (including current portion of
bank loan of P24,000) ............................................................... P 434,616
Income tax payable............................................................................
100,205
Long-term debt..................................................................................
72,000
Ordinary share capital .......................................................................
2,042,000
Retained earnings ..............................................................................
978,599
Unrealized loss due to decline in value of investment in SMC .........
(20,000)
Revaluation increment.......................................................................
96,000
Total Liabilities and Shareholders Equity
P 3,703,420
FELICITY COMPANY
Income Statement
Sales .................................................................................................. P 2,757,124
Cost of sales ......................................................................................
2,257,604
Gross profit........................................................................................ P
499,520
Operating expenses ...........................................................................
(83,522)
Other charges.....................................................................................
(102,000)
19-18

Income from continuing operations before tax.................................. P
Provision for income tax (35%) ........................................................
Income from continuing operations after tax .................................... P
Discontinued operations (net) ...........................................................
Net income ........................................................................................ P
19-8.
313,998
109,899
204,099
(6,500)
197,599
Learn Company
Condensed Comparative Income Statements
Construction revenue
Construction expense
Other expenses
Income before income taxes
Income tax expense
Net income
2008
P420,000
(182,000)
(70,000)
P168,000
(50,400)
P117,600
2009
P900,000
(420,000)
(80,000)
P400,000
(120,000)
P280,000
2007
P200,000
(80,000)
(50,000)
P 70,000
(21,000)
P 49,000
Comparative Statements of Retained Earnings
Balance at beginning of year,

as previously reported
Add: Adjustment for the
cumulative effect on prior years
of applying retroactively the
new method of accounting for
long-term contracts (net of
income taxes)
as adjusted
Net income
Balance at end of year
2009
2008
P 77,000
P 7,000
89,600
42,000
2007
P
P166,600
P 49,000
280,000
117,600
49,000
P446,600
P166,600
P 49,000
Note: The company has accounted for revenue and costs for long-term
construction contracts by the percentage-of-completion method in 2009, whereas
in prior years revenues and costs were determined by the completed-contract
method. The new method of accounting for long-term contracts was adopted to
(state justification for change in accounting principle) and financial statements of
prior years have been restated to apply the new method retroactively. The effect
19-19
of the accounting change on income of 2009 and on income as previously reported

in 2007 and 2008 is as follows:
Net income
Earnings per ordinary share
2009
P112,000
P11.20
Increase
2008
P47,600
P4.76
2007
P42,000
P4.20
The balances of retained earnings for 2008 and 2009 have been adjusted for the
after-tax effect of applying the new method of accounting retroactively.
19-9.
P49,000 P7,000
(P49,000 + P117,600) (P7,000 + P70,000)
P280,000 [(P600,000 P280,000 P80,000) x (1 0.30)]
Goody Construction Company

Requirement (1)
2007
Jan. 1
Construction in Progress
Retained Earnings [P70,000 x (1 0.30)]
Deferred Tax Asset
a
[(P100,000 + P120,000) + (P125,000 +
P75,000)] (P100,000 + P250,000)
70,000 a
49,000
21,000
Requirement (2)
GOODY CONSTRUCTION COMPANY
Condensed Comparative Income Statements (Partial)

Income taxes at 30%
Net income
(100,000 shares)
2007
P400,000
(120,000)
P280,000
P2.80
2006
P200,000
(60,000)
P140,000
P1.40
2005
P220,000
(66,000)
P154,000
P1.54
19-20

Comparative Statements of Retained Earnings
2006
2007
as previously reported
Add: Adjustment for the
cumulative effect on prior years
of applying retroactively
applying the new method of
accounting for long-term
contracts (net of income taxes)
as adjusted
Net income
Balance at end of year
2005
P245,000
P 70,000
49,000
84,000
P294,000
280,000
P574,000
P154,000
140,000
P294,000
0
P
0
154,000
P154,000
P100,000 x (1 0.30)
P250,000 x (1 0.30) + P70,000
[(P100,000 + P120,000) P100,000] x (1 0.30)
[(P100,000 + P120,000 + P125,000 + P75,000) (P100,000 + P250,000)]

x (1 0.30)
Note: The company has accounted for revenue and costs for long-term
construction contracts by the percentage-of-completion method in 2007, whereas
in prior years revenues and costs were determined by the competed-contract
method. The new method of accounting for long-term contracts was adopted to
(state justification for change in accounting principle) and financial statements of
prior years have been restated to apply the new method retroactively. The effect
of the accounting change on income of 2007 and on income as previously reported
in 2005 and 2006 is as follows:
Net income
2007
P(49,000)
P(0.49)
Increase
2006
P(35,000)
P(0.35)
2005
P84,000
P0.84
The balances of retained earnings and deferred taxes for 2006 and 2007 have been
adjusted for the after-tax effect of applying the new method of accounting
retroactively:
f
(P220,000 P100,000) x (1 0.30)
(P200,000 P250,000) x (1 0.30)
[P400,000 (P820,000 P350,000)] x (1 0.30)
19-21
Items Restated:
On the 2005 and 2006 income statements, construction revenues and expenses
would be restated to the appropriate amounts for the percentage of completion
method. The construction in progress, deferred income taxes, and retained
earnings on the balance sheets would also be restated.
19-10.
Sand Company
Requirement (1)
a.
Incorrect entries:
Building
Notes Payable
Depreciation Expense: Building
(P60,000 30)
Accumulated Depreciation: Building
Correct entries:
Building
Discount on Notes Payable
Notes Payable
a
60,000
2,000
2,000
40,981
19,019
60,000
P60,000 x 0.683013

Interest Expense
b
P40,981 30
Interest computed using effective

interest method: 10% x P40,981
Entries to correct error:

Building
Interest Expense
b.
60,000
Retained Earnings
Cost of Goods Sold
To correct error from prior year.
1,366
4,098
b
c
1,366
4,098
19,019
19,019
634
4,098
634
4,098
40,000
40,000
19-22

Cost of Goods Sold
Inventory
To correct error in current year.
c.
15,000
15,000
The error from 2005 was counterbalanced at

the end of 2006, so it can be ignored.
Retained earnings
Salaries and Wages Expense
To correct error in salary and wage
accrual in 2006.
18,000
Salaries and Wages Expense

Salaries and Wages Payable
To accrue salaries and wages at
December 31, 2007.
10,000
18,000
10,000
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 2007)
Retained Earnings
Building
d
b.
19,019
Correction of interest expense

understatement of P4,098 less
depreciation overstatement of P634
The error from 2006 was counterbalanced

by the end of 2005, so it can be ignored.
Retained Earnings
Inventory
c.
14,921
634
3,464
15,000
15,000
The errors from 2005 and 2006 were counterbalanced by the end of 2006 and
2007; respectively, so they can be ignored.
Retained Earnings
Salaries and Wages Payable
10,000
10,000

19-11.
19-23
Play Company
Requirement (1)
SFAS No. 13 paragraphs 42 and 43 state that a change in accounting policy
should be applied retroactively unless the amount of any resulting adjustment that
relates to prior periods is not reasonably determinable. Any resulting adjustment
should be reported as an adjustment to the opening balance of retained earnings.
Comparative information should be restated unless it is impracticable to do so.
The financial statements, including the comparative information for prior periods,
are presented as if the new accounting policy had always been in use. Therefore,
comparative information is restated in order to reflect the new accounting policy.
The amount of the adjusting relating to periods prior to those included in the
financial statements is adjusted against the opening balance of retained earnings of
the earliest period presented. Any other information with respect to prior periods,
such as historical summaries of financial data, is also restated.
PLAY COMPANY
Worksheet to Correct Income Before Income Taxes
Income before income taxes, before adjustments

Adjustments:
Depreciate certain equipment over 8-year life
instead of 10-year life (Schedule 1)
Correct 2006 error
Record 2007 provision for doubtful accounts
(P58,500,000 x 0.2%)
Increase estimated warranty liability
Effect of change in accounting principle from
expensing to capitalizing relining costs in the
year of the change (Schedule 2)
Furnace A (Jan. 2006)
Furnace B (Jan. 2007)
Net adjustments
Year Ended December 31

2007
2006
P4,030,000
P3,330,000
(25,000)
180,000
(117,000)
(170,000)
(56,000)
240,000
52,000
P4,082,000
-(180,000)
---
224,000
-44,000
P3,374,000
Schedule 1:
Computation of Adjusted Depreciation
Cost of equipment (no salvage value)
P1,000,000
Depreciation based on 10-year life

Depreciation based on 8-year life
Adjustment
P 100,000
(125,000)
P (25,000)
19-24

Schedule 2:
Computation of Effect of Change in Accounting
Principle From Expensing to Capitalizing
Relining Costs on the Year of the Change
Capitalization of Furnace B
Depreciation on Furnace B based on 5-year life
(P300,000 x 20%)
Depreciation on Furnace A based on 5-year life
(P280,000 x 20%)
Adjustment
P300,000
(60,000)
(56,000)
P184,000
Requirement (2)
PLAY COMPANY
Effect Before Income Taxes
of Change in Accounting Principle From
Expensing to Capitalizing Relining Costs
For Year Ended December 31, 2007
Capitalization of Furnace A
Depreciation on Furnace A based on 5-year life
(P280,000 x 20%)
Adjustment
19-12.
P280,000
(56,000)
P224,000
Jo Francisco, Inc.
Item
1.
2.
3.
4.
5.
6.
Net Income for 2005

Understated
Overstated
P14,100
0
P 7,000
0
0
P22,000
P33,000
0
0
P20,000
P18,200
0
Retained Earnings 12/31/06

Understated
Overstated
0
0
P 5,000
0
0
P11,000
P33,000
0
0
P10,000
0
0
Although explanations were not required in answering the question, they are
included below for your interest.
Explanations:
1.
The net income would be understated in 2005 because interest income is

understated. The net income would be overstated in 2006 because interest
income is overstated. The errors, however, would counterbalance (wash) so
that the Balance Sheet (Retained Earnings) would be correct at the end of
2006.
19-13.
19-25
2.
The depreciation expense in 2005 should be P1,000 for this machine. Since
the machine was bought on July 1, 2005, only one-half of a year should be
taken in 2005 (P8,000/4 X 1/2 = P1,000). The company expensed P8,000
instead of P1,000 so net income is understated by P7,000 in 2006. An
additional P2,000 of depreciation expense should have been taken in 2006. At
the end of 2006, retained earnings would be understated by P5,000 (P7,000
P2,000).
3.
PAS 38, paragraphs 54 to 57 govern the accounting for research and

development costs. Net income in 2005 is overstated P22,000 (P33,000
research and development costs capitalized less P11,000 amortized). By the
end of 2006, only P11,000 of the research and development costs would
remain as an asset. Therefore, retained earnings would be overstated by
P11,000 (P33,000 research and development costs P22,000 amortized).
4.
The security deposit should be a long-term asset, called refundable deposits.

The P8,000 of last months rent is also an asset, called prepaid rent. The net
income of 2005 is understated by P33,000 (P25,000 + P8,000) because these
amounts were expensed. Retained earnings will continue to be understated by
P33,000 until the last year of the lease. The security deposit will then be
refunded, and the last months rent should be expensed.
5.
P10,000 or one-third of P30,000 should be reported as income each year. In

2005, P30,000 was reported as income when only P10,000 should have been
reported. Because P20,000 too much was reported, the net income of 2005 is
overstated. At the end of 2006, P20,000 should have been reported as income,
so retained earnings is still overstated by P10,000 (P30,000 P20,000).
6.
The ending inventory would be understated since the merchandise was

omitted. Because ending inventory and net income have a direct relationship,
net income in 2005 would be understated. The ending inventory of 2005
becomes the beginning inventory of 2006. If beginning inventory of 2006 is
understated, then net income of 2006 is overstated (inverse relationship). The
omission in inventory over the two-year period will counterbalance, and
retained earnings at the end of 2006 will be correct.
JC Patrick Corporation
Net income, as reported

Rent received in 2006, earned in 2007
Wages not accrued, 12/31/05
Inventory of supplies, 12/31/05
Corrected net income
2006
P29,000
(1,300)
1,100
(1,500)
(1,300)
740
P26,740
2007
P37,000
1,300
1,500
(940)
(740)
1,420
P39,540

Comprehensive Audit of Balance Sheet and Income Statement Accounts

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CHAPTER

Accumulated depreciation - machinery

(b) Factory operating expenses

(a) Accumulated depreciation - building

Building (P315,000 x 2%)

Merchandise inventory, 12.31.07 B/S

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Factory operating expenses

Sinking fund assets