1

ACCOUNTING FOR CHANGES AND CORRECTION OF ERRORS Definition of Terms Accounting policies specific principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting the financial statements. Fund ment l errors are errors discovered in the current period with such significance, that the financial statements of one or more prior periods can no longer be considered to have been reliable at the date of their issue. Re sons !"# Accounting C" nges Occur : 1. The accounting profession may mandate that a new accounting principle is to be used. 2. Changing economic conditions 3. Changes in technology and in operations 4. ew e!perience or new information may prompt companies to change its estimate of revenues or e!penses. T$%ES OF ACCOUNTING CHANGES &' C" nge in Accounting %rinciples This is a change from one generally accepted accounting principle to another generally accepted accounting principle. "doption of a new principle in recognition of events that have occurred for the 1st time is not a change in accounting principle. There is no change in accounting principle when the depreciation method adopted for a newly ac#uired asset is different from the method or methods used for previously recorded assets of similar class. " change from a principle that is not generally accepted to one that is generally accepted is considered to be an error correction than a change in accounting principle. Accounting %rocedure( )enc"m r* tre tment " change in accounting policy$principle should be applied retroactively unless the amount of any resulting ad%ustment that relates to prior periods is not reasonably determinable. "ny resulting ad%ustment should be reported as an ad%ustment to the opening balance of the retained earnings. Comparative information should be restated unless it is impracticable to do so. +' C" nge in Accounting Estim te This is a change that occur as a result of new information or ac#uisition of additional e!perience. Changes in estimates are viewed as normal recurring corrections and ad%ustments or the natural result of the accounting process. &etroactive treatment is prohibited. Accounting %rocedure( a. &eport current and future financial statements on the new basis. b. 'resent prior period financial statements as previously reported. c. (a)e no ad%ustment to current period opening balances.

NOTE( *henever it is impossible to determine whether a change in principle or a change in estimate has occurred, or if an asset is affected by both a change in principle and a change in estimate during the same period, the change should be accounted for as a change in estimate rather than a change in principle. CORRECTION OF ERRORS o company whether large or small is immune from errors. +rrors may be intentional or unintentional. ,ntentional errors are significant because of the presence of fraud or intent to deceive. These errors are made for the purpose of concealing fraud or

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misappropriation, evading ta!es, manipulating or window-dressing the company.s financial statements. /nintentional errors were not deliberately committed. They result from carelessness or ignorance on the part of the company.s personnel or it may result from poor internal control. The ris) of material errors may be minimi0ed through the installation of good internal control and the application of sound accounting procedures. 'rior period ad%ustments, also called fundamental errors are reported in the current year as ad%ustment in the beginning balance of the &etained +arnings account. 'rior period statements should be restated to correct the error when comparative statements are prepared. Accounting %rocedure( 1. ,f detected in the period the error occurred, correct the accounts through normal accounting cycle ad%ustments. 2. ,f detected in subse#uent period, ad%ust errors by ma)ing prior period ad%ustments directly to &etained +arnings or restate the beginning balance of the &etained +arnings account. 3. Correct all previously presented prior period statements. +!amples of "ccounting errors: a. " change from an accounting principle that is not generally accepted to an accounting principle that is generally accepted. b. (athematical mista)es c. (ista)e in the application of accounting of accounting principle d. 1versight e. (isuse of facts f. ,ncorrect classification of e!pense as an asset or vice versa g. Changes in estimates which are not prepared in good faith T$%ES OF ERRORS &' ) l nce S"eet Errors This type of error refers to improper classification of real accounts such as assets, liabilities or stoc)holders. e#uity accounts. They have no effect on net income +' Income St tement Errors This type of error affects only the presentation of nominal accounts in the ,ncome 2tatement. ,t involves the improper classification of revenues and e!penses accounts, hence, only the details of the ,ncome 2tatement are misstated. " reclassifying entry is necessary only if the error is discovered in the same year it is committed. ,t has no effect on the 3alance sheet and in the ,ncome 2tatement. ,f the error is discovered in a subse#uent year, no classification entry is necessary. ,' Com-ined ) l nce S"eet nd Income St tement errors This affects both the balance 2heet and the ,ncome 2tatement because they result in the misstatement of net income. Cl ssific tions of Com-ined ) l nce S"eet nd Income St tement Errors( ' Counter ) l ncing Errors +rrors which if not detected are automatically offset or corrected over two periods. Restatement is necessary even if a correcting journal entry is not required. Effect( et ,ncome of two successive periods are misstated. The amount of misstatement in one period is e#ual to but opposite in effect in the income of the ne!t period. Counterbalancing errors include the misstatements of the following accounts: 1. ,nventories to include the following a. 'urchases b. 2ales 2. 'repaid e!penses 3. 4eferred ,ncome 4. "ccrued e!pense

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5. "ccrued ,ncome

GUIDE.INES 3oo)s are open 1. ,f the error is already counterbalanced and the company is in the second year, an entry is necessary to correct the current period and to ad%ust the beginning balance of the &etained earnings. 2. ,f the error is not yet counterbalanced, an entry is necessary to ad%ust the beginning balance of the &etained earnings and correct the current period. 3oo)s are closed 1. ,f the error is already counterbalanced, no entry is necessary. 2. ,f the error is not yet counterbalanced, an entry is necessary to ad%ust the present balance of the &etained earnings. -' Non Counter ) l ncing Errors +rrors which ta)e longer than two periods to correct themselves. This type of error is carried over to the subse#uent accounting period until corrected or until the balance sheet item involved is removed from the accounts by sales, retirement or other means of disposal.

GUIDE.INES IN ERROR ANA.$SIS 1. *hat accounts are affected6 2. 7ow were these accounts affected6 *as there an understatement or an overstatement6 3. *hat was the erroneous entry made or what was the entry omitted6 4. *hat is the correct entry6 5. *hat is the necessary ad%usting or correcting entry6 END

%RO).E/ & ,n your e!amination of the financial statements of 8&,27"( C1&'., for the year ended 4ecember 31, 2994, you discovered the following errors. 'repare the necessary ad%usting entries. 1. ,nterest collection from a notes receivable amounting to '3,599 which was received on 4ecember 39, 2994 was deposited and recorded on the same day by a credit to sales. 2. " staled chec) of '12,999 which had been outstanding for more than si! months was included in the list of outstanding chec)s. This was in payment of "ccounts 'ayable 3. 'ayment of '4,599 for freight charges on merchandise purchased on 4ecember 1:, 2994 was debited to freight out account. 4. 1n 4ecember 31, 2993, the physical count was overstated by '5,999. 5. ,mprovements on building of '199,999 had been charged to e!pense on ;anuary 91, 2994. ,mprovements have a life of 5 years. <. 8&,27"( C1&'. issued 5,999 shares of ' 199 par value capital stoc) for '559,999 on ;anuary 14, 2993. The proceeds were credited to the Capital 2toc) account. =. 1n ;anuary 91, 2994, an e#uipment costing '=9,999 was sold for '35,999. "t the date of sale, the e#uipment has an accumulated depreciation of '43,=59. The cash received was recorded as other income in 2994. " '15,999 collection from 2mart Co. was correctly recorded in the general ledger but was erroneously credited to the subsidiary ledger account of 2murf Corp. ,nsurance premium of '45,999 for three years paid in ;anuary 2993 was charged to e!penses in 2993. 1n 4ecember 31, 2993, goodwill estimated by the 3oard of 4irectors at '399,999 was set up by a credit to &etained +arnings. 1n 4ecember 2>, 2994, 8&,27"( C1&'. issued chec)s to its creditors amounting to

:. >. 19. 11.

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'=5,999. These chec)s were released on ;anuary 4, 2995. 12. " chec) for '29,999 from a customer to apply to his account was received on 4ecember 39, 2994 but was not recorded until ;anuary 4, 2995. 13. " customer.s deposit of '<9,999 for goods to be delivered in ;anuary 2995 was deducted from accounts receivable. 14. " chec) was cleared by the ban) as '5,299 on 4ecember 95, 2993, but was recorded by the boo))eeper as '2,599. This was in payment of an employee cash advance. 15. 1n the last day of 2994, the company received a '>9,999 prepayment from a tenant for 2995 rent of a building. ,t was recorded as rent revenue. %RO).E/ + ,n early 2995, while reviewing ?+@, , C.As 2994 financial records, ?+@, , C.s accountant discovered several errors. Bor each of the error listed below, indicate the effect on net income for both 2993 and 2994 and the necessary ad%usting entries, assuming : a. boo)s are still open b. boo)s are already closed 1. ?+@, , C. fre#uently borrows from the ban) in order to maintain sufficient operating cash. The following loans were at 12C interest rate, with interest payable at maturity. ?+@, , C. repaid each loan on its scheduled maturity date. 4"T+ 1B D1" "(1/ T ("T/&,TE 4"T+ 11.91.93 59,999 19.31.94 92.91.94 159,999 9=.31.94 95.91.94 :9,999 91.31.95 ?+@, , C. records interest e!pense when the loans are repaid. "s a result, interest e!pense of '15,999 was recorded in 2994 2. 'ollution control devices costing ':4,999 which is high in relation to the cost of the original e#uipment, were installed in 2993 and were charged to repairs in 2993. The original e#uipment referred to has a remaining useful life of < years on 4ecember 39, 2993 and is being depreciated using the straight line method. "ssume ta! rate of 32C. 3. ?+@, , C. receives subscription payments for annual Fone yearG subscriptions to its maga0ine. 'ayments are recorded as revenue when received. "mounts received but unearned at the end of each of the last three years are shown below. 2992 2993 2994 /nearned revenues '249,999 '399,999 '352,999 ?+@, , C. failed to record the unearned revenues in each of the three years. 4. ?+@, , C. has estimated bad debts using the percentage-of-sales method since their business began operations in 2992. ,nformation relating to bad debts and sales is as follows: +stimated 3ad 4ebt +!pense "ctual Eear 2ales FC of 2alesG 3ad 4ebts 2991 ' :=,999 '2,<19 '1,299 2992 123,999 3,<>9 2,:59 2993 14=,999 4,419 3,222 "t the beginning of 2994, ?+@, , C. proposes changing their estimation of bad debt e!pense from 3 percent of sales to 2 percent. 2ales for the year totaled '1,<39,999 and actual bad debts amounted to '3,=29. The company had already made an ad%ustment based on the old rate. 5. 3eginning merchandise inventory F;anuary 91, 2993G was understated by ':,<49. <. (erchandise costing '24,999 was sold for '49,999 on 4ecember 2>, 2993 but the sale was recorded in 2994. The merchandise was shipped B13 shipping point and was not included in ending inventory. =. " one-year note receivable of '><,999 was held by ?+@, , C. beginning 1ctober 1, 2993. 'ayment of the 19 percent note and accrued interest was received upon maturity. o ad%usting entry was made on 4ecember 31, 2993.

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:. +#uipment with a ten-year life was purchased on ;anuary 1, 2993, for '3>,299. o depreciation e!pense was recorded during 2993 or 2994. "ssume that the e#uipment has no salvage value and that ?+@, , C. uses the straight-line method for recording depreciation. >. " two-year fire insurance policy was purchased on (ay 1, 2993, for '5=,599. The entire amount was debited to 'repaid ,nsurance. o ad%usting entry was made in 2993 or 2994. 19. "ccrued e!penses omitted at the end of the year are '43,999 in 2992, '43,999 in 2993 and '>2,999 in 2994. %RO).E/ , Eou have been engaged to audit the accounts of +B/ C1&'. for the first time in 2994. 4uring the audit you found the following: $e r ending Decem-er ,& +00+ +00, +001 1missions from the boo)s: a. "ccrued e!penses, 4ec. 31 '1:,999 '2=,999 '>,999 b. "ccrued income, 4ec. 31 3,<99 4,959 3,159 c. 'repaid e!penses, 4ec. 31 19:,999 :1,999 54,999 d. /nearned income. 4ec. 31 31,599 22,599 13,599 RE2UIRE/ENTS( EFFECT a. Bor each number indicate the effect by writing O for overstated, U for understated or 3 for no effect. b. ,ndicate the amount of over or under statement. A/OUNT

HHHHHHHHHHHHHHHHHH1. 1n 2994 net income of the omission of both accrued e!pense and unearned income at the end of 2992, 2993 and 2994 when considered together. HHHHHHHHHHHHHHHHHH2. 1n &etained +arnings after closing at 4ec. 31, 2994 of the omission unearned income at the end of 2992, 2993 and 2994. HHHHHHHHHHHHHHHHHH3. 1n wor)ing capital at 4ecember 31, 2994 of the omission of accrued income at the end of 2992, 2993 and 2994 when considered together. HHHHHHHHHHHHHHHHHH4. 1n wor)ing capital at 4ec. 31, 2994 of the omission of unearned income at the end of 2992, 2993 and 2994. HHHHHHHHHHHHHHHHHH5. 1n &etained +arnings after closing at 4ec. 31, 2994 of the omission of accrued e!penses at the end of 2992, 2993 and 2994. HHHHHHHHHHHHHHHHHH<. 1n wor)ing capital at 4ec. 31, 2994 of the omission of prepaid e!penses at the end of 2993 and 2994. HHHHHHHHHHHHHHHHHH=. 1n &etained +arnings after closing at 4ec. 31, 2994 on the omission of prepaid e!penses at the end of 2992 and 2993. HHHHHHHHHHHHHHHHHH:. 1n 2993 net income of the omission of accrued e!penses at the end of 2992. HHHHHHHHHHHHHHHHHH>. 1n 2994 net income of the omission of accrued income at the end of 2992, 2993 and 2994 when considered together. HHHHHHHHHHHHHHHHHH19. 1n the 2993 net income of the omission of both accrued income and prepaid e!pense at the end of 2992 and 2993. HHHHHHHHHHHHHHHHHH11. 1n the 2994 net income of the omission of prepaid e!penses at the end of 2993 and 2994. HHHHHHHHHHHHHHHHHH12. 1n 2994 net income of the omission unearned income at the end of 2992 and 2993. HHHHHHHHHHHHHHHHHH13. 1n &etained +arnings before closing at 4ec. 31, 2992 of the omission of accrued income at the end of 2992. HHHHHHHHHHHHHHHHHH14. 1n the 2994 net income of the omission of accrued e!penses at the end of 2992, 2993 and 2994 when considered together. HHHHHHHHHHHHHHHHHH15. 1n &etained +arnings after closing at 4ec. 31, 2994 of the omission of both accrued e!penses and unearned income at the end 2992, 2993 and 2994 when considered together.

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%RO).E/ 1 "n e!amination of the accounting records of (ervyn Company for the year ended 4ecember 31, 2994 indicated that several errors were committed as follows: 1. 2. 3. 4. 'urchase of merchandise in the amount of '19,<25 in 2993 was not recorded until the following year but was included in the year.s inventory. ,n "ugust 2994, an ':,=59 invoice for office supplies was charged to purchases. 1ffice supplies are e!pensed as purchased. ,nventory on 4ecember 31, 2994 was overstated by '5<,259. "n e#uipment costing '125,999 and with an accumulated depreciation of '=5,999 was sold for <:,=59 on ;anuary 1, 2994. ,n addition, depreciation was recorded for the e#uipment for 2994 at the rate of 19C. 'roceeds from sale was credited to the +#uipment account. Bootings and e!tensions showed that the inventory on 4ecember 31, 2993 was overstated by ' 5>,3=5. 4epreciation of e#uipment costing '15,999 bought on ;une 39, 2991 was computed based on an estimated useful life of : years. The engineers estimated that the useful life of the asset should be revised to 19 years effective 2994. The company still provided for depreciation based on the old estimate. ,nterest of '<,259 on notes receivable was not recogni0ed on 4ecember 31, 2994. 2ales on account of '25,999 in 4ecember 2994 were recorded in 2995. Ta!es of '1:,=59 applicable for the fourth #uarter of 2993 were paid and charged to e!pense on ;anuary 29, 2994. " fully depreciated machinery was sold on 4ecember 31, 2994 but the sale was not recorded until 2995. The proceeds from sales on this machinery costing '43=,599 was '31,259. 1n 4ecember 29, 2993, a cash advance of '3=,599 from a customer was received for goods to be delivered in ;anuary 2994. The amount of cash received was credited to sales. The company.s gross profit is 29C of cost. ,nsurance premium for a three year period amounting to '15,999 was charged to e!pense on ;anuary 1, 2993 and no ad%ustment was made on year end. " collection of '31,259 from a customer was received on 4ecember 31, 2994 but not recorded until ;anuary 4, 2995. " customer.s chec) of ':,=59 was returned by the ban) on ovember 3, 2994 due to lac) of sufficient funds. "d%ustment was made the following year. 4epreciation computed on the building for the years 2993 and 2994 was overstated by '12,599 per year.

5. <.

=. :. >. 19. 11. 12. 13. 14. 15.

&ecords of (ervyn Company reported the following net ,ncome. 2993 ' 54<,:=5 2994 <25,999 RE2UIRE/ENTS( 1. 'repare a wor)sheet showing the corrected income for 2993 and 2994. 2. 'repare the necessary ad%usting entries on 4ecember 31, 2994 assuming: a. 3oo)s are still open b. 3oo)s are closed %ro-lem 4 ,n early 2995, while reviewing T71("2 C1&'..s 2994 financial records, its accountant discovered several errors. Bor each of the error listed below, indicate the effect on net income for both 2993 and 2994 assuming no correction was made and the company uses the periodic system of inventory. 1. 8oods shipped to consignee amounting to '2,599 in 2993 were reported as sales. 8oods in the hands of the consignee at the end of 2993 were not recogni0ed for inventory purposes. 2ale of such goods in 2994 and collections on such sales were recorded as credits to receivables established with consignees in 2993. ,nsurance costs incurred amounting to '15,999 but unpaid in 2993 were not recorded until paid in 2994.

2.

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3. The total of one wee).s sales amounting to '2,259 in 2993 was credited to 8ain on sales-(achineries 4. 2993 year end purchases of '19,999 were not recorded until the beginning of 2994. The inventory associated with these purchases was omitted from the ending inventory count in 2993. 5. (achinery was sold in (ay of 2994, but the company continued to deduct depreciation for the remainder of 2994 although the asset was removed from the boo)s in (ay. Cost of the asset purchased in 1ctober of 2991 was '12,599 and estimated to have a useful life of 19 years, The company follows the straight line method of computing depreciation. <. " chec) of '<,259 for ;anuary 2994 rent was received and recorded as revenue at the end of 2993. =. 2993 year end purchase of '=,599 of inventory were not recorded until the beginning of 2994 although the inventory was correctly counted at the end of 2993. :. ,nterest receivable of '1,599 in 2993 was not recorded until 2994. >. ,nterest accrued of '4,999 in 2993 on a note payable was not recorded until it was paid in 2994. 19. Certain items of ending inventory amounting to '5,:=5 were accidentally not counted at the end of 2993. 11. 8oods sold on account in 2993 amounting to '5,999 were not recorded as sales until 2994. 12. o depreciation amounting to '4,3=5 was ta)en in 2993 for e#uipment sold in "pril 2993. The company reports on a calendar year basis and computes depreciation to the nearest month. RE2UIRE/ENTS( 4etermine the effect of the above mentioned errors on the balance sheets and the income statement prepared in 2993 and 2994 and compute for the corrected income assuming reported income are as follows: 2993 ' 599,999 2994 3=5,999 %ro-lem 5 Bor three years, 3D/+3,&42 (42+. failed to recogni0e accruals, prepayments and other transactions in its accounts. &eported net income and listing of the error appear below:

+00+

+00,

+001

/nad%usted net income FlossG 159,999 599,999 F 125,999G 1. Chec)s written in 4ecember and mailed on ;anuary 3 of the following year. 259 3=5 599 2. 1verstatement of ending inventories 3<,999 2:,999 3. Bailed to recogni0e unearned revenue <,259 11,259 4. Bailed to record purchase on account and mdse properly included in ending inventory 59,999 5. Bailed to recogni0e unused supplies at the end of year 3,=59 5,999 <. Bailed to record accrued commission e!penses 25,999 31,259 <9,999 =. /nderstatement of depreciation e!penses 15,999 1:,=59 1:,=59 :. *orthless accounts written not written off by year end <25 =59 :=5 >. Bailed to recogni0e gain on sale of landI Dand credited for the proceeds =5,999 19. Bailed to record accrued salaries 1<,259 22,599 -

Re6uirements( 'repare a schedule to correct the reported net income for each year and the ad%usting entries to correct the boo)s at the end of 2994.

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%ro-lem 7 1. (E2T+&E2C1T (" /B"CT/&, 8 purchased a machine on ;anuary 1, 2999 for '59,999. "t the time, it was determined that the machine has an estimated useful life of 19 years and an estimated residual value of '2,999. The company used the double declining balance method of depreciation. 1n ;anuary 1, 2994, the company decided to change its depreciation method from double declining balance to straight line. The machine.s remaining useful life was estimated to be 5 years with a residual value of ' 1,999. 2. o allowance had been set up for estimated uncollectible receivables. The company decided to set up such an allowance for the estimated probable losses as of 4ecember 31, 2993, for 2993 accounts of '359 and for 2994 accounts of '=59. ,t was also decided to correct the charge against each year so that it shows the losses Factual and estimatedG relating to that year.s sales. "ccounts have been written off to bad debts e!penses as follows: In +00, In +001 2993 accounts ' 299 ' 1,999 2994 accounts :99 3. +#uipment ac#uired by (E2T+&E2C1T (" /B"CT/&, 8 for '39,999 on ;une 39, 2992 was sold for '2<,999 cash on ;uly 1, 2994. The proceeds from the same were credited to the e#uipment account. The company depreciates e#uipment at 19C a year. 4epreciation is ta)en up at year- end computed on a monthly basis. 4epreciation of '1,<99 was recorded in 2994. 4. 1n (ay 91, 2992, (E2T+&E2C1T (" /B"CT/&, 8 ac#uired a machine in e!change for 1,999 shares of its own '199 par value common stoc) having a fair mar)et value of '129 on this date. The machine was recorded in the accounts at '199,999. Company policy is to ta)e one half years depreciation on all asset ac#uisitions or disposals during the year. (achinery is depreciated on a straight line basis Fno salvage value based on an estimated life of 19 years.G The company has recorded depreciation charge of '1,599 on this machine from ac#uisition to the end of the current period. 5. (E2T+&E2C1T (" /B"CT/&, 8 purchased a machine on ;anuary 1, 2991 for '1,599,999. "t the date of ac#uisition, the machine had an estimated useful life of < years with no residual value. The machine is being depreciated on a straight-line basis. 1n ;anuary 1, 2994, management determined as a result of additional information, that the machine had an estimated useful life of : years from the date of ac#uisition with no residual value. RE2UIRE/ENT: ;ournal entries

%RO).E/ 8 IN9ENTORIES 1. Eou are e!amining the financial statements of 41 ;17 C1&'1&"T,1 which ends on 4ecember 31. 41 ;17 C1&'. uses the physical inventory system of accounting for inventory. ,n the course of your e!amination, you discovered the errors below. 1. 8oods received in ;anuary 2995 were recorded as purchase on account in 4ecember 2994. The goods were included in the 2994 ending inventory. 2. The inventory at 4ecember 31, 2994 is understated as a result of errors in physical count. 3. 8oods received in 4ecember 2994 were recorded as purchases when paid in 2995. The goods were e!cluded from the 2994 ending inventory. 4. The inventory at 4ecember 31, 2994 is overstated as a result of the inclusion of goods ac#uired on consignment. 5. 8oods received in ;anuary 2995 were recorded as purchase on account in 4ecember 2994. The goods were e!cluded from the 2994 ending inventory. <. 8oods received in 4ecember 2994 were recorded as purchases when paid in 2995. The goods were included in the 2994 ending inventory. +nter the effect of the errors in the solution guide below. /se the following symbols: 1-1verstated, /-/nderstated J- o effect & + , 1 4 5

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,ncome 2tatement- 2994 'urchases HHHH Cost of 2ales HHHH et income HHHH 3alance 2heet- 4ecember 31, 2994 ,nventory HHHH "ccounts 'ayable HHHH &+ before closing HHHH &+ after closing HHHH ,ncome 2tatement- 2995 'urchases HHHH 3eginning inventory +nding inventory HHHH Cost of 2ales HHHH et income HHHH 3alance 2heet- 4ecember 31, 2995 ,nventory HHHH "ccounts 'ayable HHHH &+ before closing HHHH &+ after closing HHHH

HHHH HHHH HHHHH HHHHH HHHHH HHHH HHHH HHHHH HHHHH HHHHH HHHH HHHH HHHHH HHHHH HHHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH

%ro-lem : ,nventory +rrors F'eriodic ,nventory 2ystemG 1. 2993 sales were recorded in 2994I goods were included in the 2993 ending inventory. 2. 2994 sales were recorded in 2993I goods were included in the 2993 ending inventory. 3. 2993 sales were recorded in 2994I goods were e!cluded from the 2993 ending inventory. 4. 2994 sales were recorded in 2993I goods were e!cluded from the 2993 ending inventory. A ) C D ,ncome 2tatement- 2993 2ales HHHH HHHHH HHHHH HHHHH +nding inventory HHHH HHHHH HHHHH HHHHH Cost of 2ales HHHH HHHHH HHHHH HHHHH et income HHHH HHHHH HHHHH HHHHH

3alance 2heet- 4ecember 31, 2993 ,nventory "ccounts '"E"3D+ &+ before closing &+ after closing ,ncome 2tatement- 2994 2ales 3eginning inventory +nding inventory Cost of 2ales et income 3alance 2heet- 4ecember 31, 2994 ,nventory "ccounts 'ayable &+ before closing &+ after closing

HHHH HHHH HHHH HHHH

HHHHH HHHHH HHHHH HHHHH

HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH

HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH HHHHH

HHHH HHHH HHHH HHHHH HHHH HHHH HHHHH HHHH HHHH HHHH HHHH HHHH HHHHH HHHHH HHHHH

%ro-lem &0

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Eou have been engaged to prepare the corrected financial statement figures for 7"22" , C. The records are in agreement with the following balance sheet: 7assan ,nc. 3alance 2heet 4ecember 31, 2994 "22+T2 Cash "ccounts receivable 52,599 otes receivable ,nventory Total 1>2,599 1>2,599 22=,599 43=,599 1,959,999 D,"3,D,T,+2 " 4 C"',T"D "ccounts payable 1=5,999 otes payable Common stoc) &etained earnings Total 359,999 4=2,599 1,959,999

" review of the records of the corporation indicates that the errors and omissions listed in the table below had not been corrected during the applicable years.
2991 1verstatement of inventory /nderstatement of inventory 15=,599 'repaid e!pense /nearned revenue "ccrued e!penses et income as reported ><,259 2992 122,599 195,999 12,259 =,999 1,319 2993 1,=59 149,999 :,=59 19,599 5,259 :=5 113,=59 2994 -

15,=59 3,599

131,259

o dividends were declared during the years and no ad%ustments were made to retained earnings. &+K/,&+(+ T2: *or)ing paper to compute for the corrected income for the years 2992, 2993 and 2994. 'repare a corrected balance sheet for 4ecember 31, 2994.

/U.TI%.E CHOICE %RO).E/S( 1. 2ean CompanyAs beginning inventory at ;anuary 1, 2994 was understated by '45,599, and its ending inventory was overstated by '>1,999. "s a result, 2ean CompanyAs cost of goods sold for 2994 was: a. /nderstated by '45,599 b. 1verstated by '45,599 c. /nderstated by '13<,599 d. 1verstated by '13<,599 2. 1n ;anuary 1, 2992, 3reton Company purchased for '429,999 a machine with a useful life of 19 years and no salvage value. The machine was depreciated by the double declining balance method and the carrying amount of the machine was '2<:,:99 on 4ecember 31, 2993. 3reton Company changed to the straight line method on ;anuary 91, 2994. *hat would be the depreciation e!pense on this machine for the year ended 4ecember 31, 29946 a. ' 2<,::9 b. ' 33,<99 c. ' 42,999 d. ' 53,=<9 3. 3randy Corp. reports on a calendar-year basis. ,ts 2994 and 2995 financial statements contained the following errors:

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2994 1ver FunderG statement of ending inventory /nderstatement of depreciation Bailure to accrue salaries at year end 2995 '19,999 ' 4,999 4,999 <,999 :,999 12,999

"s a result of the above errors, 2995 income would be: a. overstated by '4,999 b. overstated by '24,999 c. overstated by '22,999 d. overstated by '1<,999 4. 1n ;anuary 91, 2991, Daden Company purchased a patent for '535,599. The patent is being amorti0ed over its remaining life of 15 years e!piring ;anuary 91, 291<. 4uring 2994, Daden Company determined that the economic benefits of the patent would not last longer than 19 years from the date of ac#uisition. *hat amount should be reported in the 3alance sheet for the patent, net of accumulated amorti0ation on 4ecember 31, 29946 a. ' 321,399 b. ' 3<=,299 c. ' 3=:,999 d. ' 3>2,=99 5. +ffective ;anuary 2, 2995, ?incaid Co. adopted the accounting principle of e!pensing advertising and promotion costs as they are incurred. 'reviously, advertising and promotion costs applicable to future periods were recorded in prepaid e!penses. ?incaid can %ustify the change, which was made for both financial statement and income ta! reporting purposes. ?incaid.s prepaid advertising and promotion costs totaled '259,999 at 4ecember 31, 2994. "ssume that the income ta! rate is 49 percent for 2994 and 2995. The ad%ustment for the effect of the change in accounting principle should result in a net charge against income in the income statement for 2995 of a. ' 9 b. ' 199,999 c. ' 159,999 d. ' 259,999 <. 1n ;anuary 91, 2991, &odney Company purchased a machine for '3><,999 and depreciated it using the straight line method using an estimated useful life of : years with no salvage value. 1n ;anuary 1, 2994, &odney Company determined that the machine had a useful life of si! years from the date of ac#uisition and will have a salvage value of '3<,999. "n accounting change was made in 2991 to reflect this additional data. The accumulated depreciation for this machine should have a balance at 4ecember 31, 2994 of: a. ' 21>,999 b. ' 231,999 c. ' 249,999 d. ' 2<4,999 =. 3art, ,nc. receives subscription payments for annual Fone yearG subscriptions to its maga0ine. 'ayments are recorded as revenue when received. "mounts received but unearned at the end of each of the last three years are shown below: 2993 2994 2995 /nearned revenues '129,999 '159,999 '1=<,999 3art failed to record the unearned revenues in each of the three years. "s a result of the omission, 2995 income was: a. overstated by '14<,999 b. understated by '14<,999 c. understated by '2<,999 d. overstated by '2<,999 :. 8lobe Corporation offers a 3 year warranty for its products. ,t previously estimated warranty costs to be 2C of sales. 4ue to technological advance in production at the beginning of 2994, 8lobe Corporation now believes 1C of sales to be a better estimate of warranty costs. *arranty cost of '149,999 and '1<:,999 were reported in 2992 and 2993

1
respectively. 2ales for 2994 was ':,=59,999. 7ow much should be reported in 2994 as warranty e!pense. a. ' :=,599 b. ' 154,999 c. ' 1=5,999 d. ' 241,599 >. "n insurance premium of '3,<99 was prepaid in 2994 covering the years 2994, 2995, and 299<. The entire amount was charged to e!pense in 2994. ,n addition, on 4ecember 31, 2995, fully depreciated machinery was sold for '<,499 cash, but the sale was not recorded until 299<. There were no other errors during 2994 or 2995, and no corrections have been made for any of the errors. ,gnore income ta! considerations. *hat is the total effect of the errors on 2995 net income6 a. et income is understated by '12,:99 b. et income is overstated by '3,<99 c. et income is understated by '1,<99 d. et income is overstated by '2,499 19. "dger Corporation purchased a machine for '159,999 on ;anuary 1, 2994. "dger will depreciate the machine using the straight-line method using a five-year period with no residual value. "s a result of an error in its purchasing records, 3adger did not recogni0e any depreciation for the machine in its 2994 financial statements. "dger discovered the problem during the preparation of its 2995 financial statements. *hat amount should "dger record for depreciation e!pense on this machine for 29956 a. ' 9 b. ' 39,999 c. ' 3=,599 d. ' <9,999 11. 1n ;anuary 1, 2992, 8ray Company purchased for '249,999 a machine with a useful life of ten years and no salvage value. The machine was depreciated by the doubledeclining-balance method, and the carrying amount of the machine was '153,<99 on 4ecember 31, 2993. 8ray changed retroactively to the straight-line method on ;anuary 1, 2994. 8ray can %ustify the change. *hat should be the depreciation e!pense on this machine for the year ended 4ecember 31, 29956 a. ' 15,3<9 b. ' 1>,299 c. ' 24,999 d. ' 39,=29 12. Dain Company reported net income of '3=5,999 in 2994. Eour audit disclosed the following errors: ,ncome received in advance in 2994 of '1:,=59 was credited to a revenue account when received. 1f the total '3,=59 was earned in 2994, '>,999 will be earned in 2995 and the remainder in 299<. '11,259 loss on sale of e#uipment in 2994 was erroneously debited to retained earnings. *hat is the correct net income for 29946 a. ' 34:,=59 b. ' 3<3,=59 c. ' 3<>,=59 d. ' 345,999 13. ;erry Company reported a net income of '525,999 in 2994. Eour audit disclosed the following: 2994 2995 1verstatement of ending inventory 21,=59 24,=59 1mission of depreciation 11,259 11,259 /nderstatement of commission receivable 1<,599 13,599 'urchase of mdse not recorded but included in the year end inventory 45,999 "d%usted net income for 2994 is: a. ' 525,999 b. ' 59=,=59 c. ' 531,999 d. ' 552,=59

1
14. ?entuc)y +nterprises purchased a machine on ;anuary 2, 2994, at a cost of '129,999. "n additional L59,999 was spent for installation, but this amount was charged erroneously to repairs e!pense. The machine has a useful life of five years and a salvage value of '29,999. "s a result of the error, a. &etained earnings at 4ecember 31, 2995 was understated by '39,999 and 2995 income was overstated by '<,999. b. &etained earnings at 4ecember 31, 2995 was understated by '3:,999 and 2995 income was overstated by '<,999. c. &etained earnings at 4ecember 31, 2995 was understated by '39,999 and 2995 income was overstated by '19,999. d. 2994 income was understated by '59,999. 15. 1n 4ecember 39, 2994, 2augie Corporation sold merchandise for '5<,259 to 2teve Company. The terms of the sale were net 39 days, 413 2hipping point. The merchandise was shipped on 4ecember 31, 2994 and arrived at 2teve Company on M ;anuary 95, 2995. 4ue to clerical error, the sale was not recorded until ;anuary 2995 and the merchandise, s)id at a 25C mar)up on cost was included in 2augieAs inventory at 4ecember 31, 2994. "s a result, 2augieAs cost of goods sold for the year ended 4ecember 31, 2994 was: /nderstated by '5<,259 /nderstated by '45,999 /nderstated by '11,259 Correctly stated ,tems 1< and 1= are based on the following information: Eou were engaged as an independent auditor of Thomas Corporation . ,n the course of your e!amination of the accounts on 4ecember 31, 2994, the end of the accounting period, you determined that certain prepaid and accrued items were not recorded in prior years and in the current year as follows: 2992 2993 2994 "ccrued e!penses 4,599 =,599 <,599 'repaid e!penses 5,999 12,999 :,999 'repaid revenues 1,299 2,=59 &evenues receivable 3,999 2,599 &etained earnings at the end of 2992 amounted to '445,999 while net income for 2993 was reported at '12<,999. The income summary account for 2994 shows a credit balance of '159,999 before any audit ad%ustments. Eou have verified that no dividends were declared in the two year period. 1<. Compute for the corrected &etained earnings balance as of 4ecember 31, 2992. a. ' 444,399 b. ' 459,999 c. ' 5=:,599 d. ' 445,999 1=. The corrected net income for the years ended 4ecember 31, 2993 and 2994 are: 2993 2994 a. '12<,999 '159,999 b. '134,299 '143,=59 c. '14<,=99 '1<:,999 d. '122,299 '155,=59 1:. 1n ;anuary 1, 2992, Carnival 2hipping bought a machine for '1,599,999. "t that time, this machine had an estimated useful life of si! years, with no salvage value. "s a result of additional information, Carnival determined on ;anuary 1, 2995, that the machine had an estimated useful life of eight years from the date it was ac#uired, with no salvage value. "ccordingly, the appropriate accounting change was made in 2995. 7ow much depreciation e!pense for this machine should Carnival record for the year ended 4ecember 31, 2995 assuming Carnival uses the straight-line method of depreciation6 a. ' 125,999 b. ' 159,999 c. ' 1:=,599 d. ' 259,999 1>. Combs, ,nc. is a calendar-year corporation whose financial statements for 2994 and 2995 included errors as follows: +nding ,nventory 4epreciation +!pense

1
2994 '39,999 overstated '25,999 overstated 2995 '19,999 understated ' :,999 understated "ssume that purchases were recorded correctly and that no correcting entries were made at 4ecember 31, 2994, or 4ecember 31, 2995. ,gnoring income ta!es, by how much should Coombs. retained earnings be retroactively ad%usted at ;anuary 1, 299<6 a. ' 2=,999 increase b. ' 2=,999 decrease c. ' =,999 decrease d. ' 3,999 decrease 29. ?oppell Co. made the following errors in counting its year-end physical inventories: 2993 ' <9,999 overstatement 2994 19:,999 understatement 2995 >9,999 overstatement "s a result of the above undetected errors, 2995 income was a. /nderstated by '1:,999 b. 1verstated by '1>:,999 c. 1verstated by '1:,999 d. /nderstated by '1>:,999 ?oppell Co. made the following errors in counting its year-end physical inventories: 2993 ' <9,999 overstatement 2994 19:,999 understatement 2995 >9,999 overstatement The entry to correct the accounts at the end of 2995 is a. &etained earnings 4:,999 Cost of sales 42,999 ,nventory >9,999 b. &etained earnings Cost of sales ,nventory ,nventory Cost of sales &etained earnings 1:,999 =2,999 >9,999 >9,999 1:,999 =2,999

21.

c.

Cost of sales 1>:,999 &etained earnings 19:,999 ,nventory >9,999 22. ,n the course of your e!amination of the financial statements of Correa Corp., a new client, for the year ended 4ecember 31, 2994, you discovered the following: a. ,nventory at ;anuary 91, 2994 had been overstated by '33,=59. b. ,nventory at 4ecember 31, 2994 was understated by '5<,259. c. "n insurance policy covering three years had been purchased on ;anuary 91, 2993 for '22,599. The whole amount was charged to e!pense in 2993. d. 4uring 2994, the company received a '15,999 cash advance from a customer for goods to be manufactured and shipped during 2995. The amount received was credited to sales. ,ncome reported for 2994 before reflecting any ad%ustment for the above information is '1:=,599. The correct income for 2994 is: a. ' 255,999 b. ' 221,259 c. ' 1<5,999 d. ' 159,999 23. Tom CompanyAs beginning inventory at ;anuary 91, 2994 was understated by '45,599 and its ending inventory was overstated by '>1,999. "s a result, Tom CompanyAs cost of goods sold for 2994 was: a. /nderstated by '45,599 b. 1verstated by '45,599

d.

1
c. /nderstated by '13<,599 d. 1verstated by '13<,599 24. The net income for 2994 reported by the accountant of "bbas Company amounted to '<34,599. Eour audit of the accounts disclosed that the following accounts were not recorded: 2993 2994 &ent received in advance 22,599 39,999 "ccrued salaries 13,599 1:,999 'repaid interest 33,=59 45,999 Commission receivable 15,=59 14,<25 4epreciation e!pense 2<,259 2<,259 +#uipment purchased at year end charged to e!pense F19 year lifeG =5,999 Compute the correct income for the year ended 4ecember 31, 2994. a. ' 5>:,:=5 b. ' <13,:=5 c. ' <55,125 d. ' <:1,3=5 25. The first e!amination of TamerAs financial statements was made for the year ended 4ecember 31, 2994. The auditor has found that Tamer had purchased another company in ;anuary 2992 and recorded goodwill of '=5,999 in connection with this purchase. ,t was determined that the goodwill had an estimated useful life of only five years because of obsolescence. o amorti0ation of goodwill had ever been recorded. Bor the 4ecember 31, 2994 financial statements, Tamer should debit amorti0ation e!pense of: "morti0ation e!penses &etained earnings a. ' 9 '=5,999 b. '15,999 '39,999 c. '25,999 ' 9 d. '45,999 ' 9

END