CHAPTER 10

Accounting Changes (Policies & Estimates) and Correction of

Errors

PROBLEM 10-1
Change in Accounting Estimate

On January 4, 2017, 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 Y ears and would have a
residual value of P60,000. The company used the double-declining-balance method to depreciate the computer
hardware.

In January 2018, Guyana's management realized that technological advancements had made the computers 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.

How much depreciation on computer hardware should be recorded in 2018?

A P144,000 C. P300,000
B. P120,000 D. P360,000

SOLUTION 10-1

Cost of computer hardware P600,000

Less: Accumulated depreciation, Dec. 31, 2017
(P600,000 x 40%) 240, 000
Book value, Jan 1, 2018 360,000
Less: Salvage value 60,000
Depreciation for 2018 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 be recognized in 2018, the
resulting book value would fall below the estimated residual value. Therefore, the maximum amount of depreciation
for 2018 should be P300,OOO (P360,OOO book,value on Jan. 1, 2018, minus P60,OOO estimated salvage value).

PROBLEM 10-2
Change in Accounting Estimate

TONGA COMPANY decided on January 2, 2018, to review its accounting practices. This is due to changing
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, 2018:

1. Tonga decided to change its allowance for bad debts from 2% to 4% of its outstanding receivables balance.
Tonga's receivable balance at December 31, 2018, was P690,000. Allowance for bad debts had a debit balance of
P2,OOO before adjustment.

2. Tonga decided to use the straight-line method of depreciation on 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, 2018. The
equipment was purchased on January 1, 2008, at a cost of P 1,100,000. 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 debts is

A. Bad debt expense 29,600

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

2. What is the amount of depreciation on equipment for the current year?

A. P45ß33 C. P13,750
B. P9,167 D. P32,083

SOLUTION 10-2
1. Bad debt expense 29,600
Allowance for bad debts 29,600

Required allowance (P690,000 x 4%) P27,600

Add: .Debit balance of allowance 2,000
Adjustment - increase in allowance P29,600

Answer: A

2. Cost of equipment P1,100,000

Less: Accumulated depreciation, Dec. 31, 2017
(see computation below) 962,500
Book value, Jan. 1, 2018 P137,500
Divide by revised remaining life /10 yrs
Revised annual depreciation P 13,750
Answer: C

Computation of Depreciation Expense – SYD METHOD

Year Depreciable Cost Fraction Depreciation
2008 P1,100,000 x 15/120 = P137,500
2009 1,100,000 x 14/120 = 128,333
2010 1,100,000 x 13/120 = 119,167
2011 1,100,000 x 12/120 = 110,000
2012 1,100,000 x 11/120 = 100,833
2013 1,100,000 x 10/120 = 91,667
2014 1,100,000 x 9/120 = 82,500
2015 1,100,000 x 8/120 = 73,333
2016 1,100,000 x 7/120 = 64,167
2017 1,100,000 x 6/120 = 55,000
Total 962,500

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

PROBLEM 10-3
In the past, PERU COMPANY has depreciated its computer hardware using the straight-line method. The computer
hardware has 10% salvage value and an estimated useful life of 5 years. As a result of the rapid advancement in
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, 2018, 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.
2015 P90,000

2016 50,000

2017 60,000

1, How much depreciation expense was recorded by Peru in 2015, 2016, and 2017?
2015 2016 2017

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 4epreciation expense that should be recognized in 2018 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, 2018, 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 OF DEPRECIATION – STRAIGHT LINE METHOD

Depreciation Expense

Computer acquisitions: 2015 2016 2017 Total

2015 (P90,000 x 90 % /5) P16,000 P16,200 P16,200 P48,600
2016 (P50,000 x 90% /5) 9,000 9,000 18,000
2017 (P60,000 x 90% /5) 10,800 10,800
Total P16,000 P25,200 P36,000 P77,400

Answer: D
2. COMPUTATION OF 2018 DEPRECIATION – SYD METHOD
2015 acquisition:
Cost P90,000
Less: Accum depreciation, Dec. 31, 2017
(P16,200 x 3) 48,600
Book value, Jan. 1, 2018 41,400
Less: Salvage value (10% x P90,000) 9,000
Remaining depreciable cost 32,400
SYD rate x 2/3 P21,600

2016 acquisition:
Cost P50,000
Less: Accum depreciation, Dec. 31, 2017
(P9,000 x 2) 18,000
Book value, Jan. 1, 2018 32,000
Less: Salvage value (10% x P50,000) 5,000
Remaining depreciable cost 27,000
SYD rate x 3/6 P13,500

2017 acquisition:
Cost P60,000
Less: Accum. Depreciation, Dec. 31, 2017 10,000
Book value, Jan. 1, 2018 49,200
Less: Salvage value (10% x P60,000) 6,000
Remaining depreciation cost 43,200
SYD rate x 4/10 17,280
Depreciation expense in 2018 52,380

Answer: C

Computation of SYD rate:

SYD = L x L+1
2
Remaining Life
At Dec. 31, 2015 SYD SYD Rate
2015 acquisition 2 years 3 2/3
2016 acquisition 3 years 6 3/6
2017 acquisition 4 years 10 4/10

No journal entry is necessary. The change in depreciation method is now accounted for as a change in accounting
estimate. Therefore, the 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 of the change, if the change affects that period only, or
b) The period of the change and future periods, if the change affects both.

The standard further provides that prospective recognition of the effect of a change in an 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, 2018, management of TUVALU COMPANY decided to make a revision in the estimates associated
with its production equipment. The equipment was acquired on January 3, 2016, for P800,000 and 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 has 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 2016 and 2017?

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 2018 as a result of the changes in
estimates?
A. P147,500 C. P125,000
B. P75,000 D. P150,000

SOLUTIONJ 10-4

1. DEPRECIATION EXPENSE FOR 2016 AND 2017

Cost of equipment P800,000

Less: Salvage value 50,000
Depreciable cost 750,000
Divide by estimated useful life /10yrs
Annual depreciation P75,000

Answer: B

2. REVISED ANNUAL DEPRECIATION

Cost of equipment P800,000
Less: Accumulated depreciation,
Dec. 31, 2017 (P75,000 x 2) 150,000
Book value, Jan. 1, 2018 650,000
Less: Revised salvage value 60,000
Remaining depreciable cost 590,000
Divide by revised useful life  4 yrs.
Revised annual depreciation P147,500

PROBLEM 10-5

Change in Accounting Estimate

ECUADOR CORP. was organized on January 1, 2015. An analysis of the company’s allowance for bad debts
account reveals the following:
 Estimated Bad Debts Actual Bad Debts

2015 P15,000 P3,000

2016 26,000 5,000

2017 35,000 9,500

2018 No provision 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 inappropriate and suggested that it be revised downward to 1%. Credit sales for the year ended December
31, 2018, totaled P950,000.

1. Prepare the entry to record bad debts 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 9,500

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

2. No adjusting journal entry is necessary. The change in bad debt rate is a change in accounting estimate. The
change shall be accounted for currently and prospectively.

PROBLEM 10-6
Change in Accounting Estimate

On January 1, 2015, COLOMBIA, 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, 2018, Colombia 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, 2018?
A. P65,000 C. P40,625
B. P92,850 D. P58,036

SOLUTION 10-6

1. No journal entry 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: Accumulated depreciation, Dec. 31, 2017
(P650,000 x 3/8) 243,750
Book value, Jan 1, 2018 406,250
Divide by revised life (10-3) /7yrs.
Revised annual depreciation P 58,036

Answer: D

PROBLEM 10-7
Changes in Accounting Estimates and Prior Period Errors

The following information pertains to VANUATU COMPANY's depreciable assets:

1. Machine X was purchased for P150,000 on January 1, 2013. 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, 2014. On the acquisition date, the expected useful
life was 12 years withno. residual value. The straight-line depreciation method was used. On January 2, 2018,
it was estimated that the remaining life o f the asset would be 4 years and that there would be a P25,000 residual
value.
3. A buildingwas purchased on January 3, 2015, The building was expected to have a useful life of 20 years with
no residual value. The straight-line depreciation method was used. On January 1, 2018, 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, 2018, relative to machine X should include a credit to
A. Accumulated depreciation ofP60,000
B. Retained earnings of P 100,000
C. Machinery of P 150,000
D. No adjusting entry is necessary

2. What is the carrying value of machine Y on January 1, 2017?

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

3. What is the depreciation expense on machine Y for 2018?

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

4. What is the book value of the building at December 31, 2017?

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

5. What is the book value of the building on December 31, 2018?

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

SOLUTION 10-7

1. Machinery –X 150,000
Accumulated depreciation — Machinery
(P150,000 x 5*/15) 50,000
Retained earnings (P150,000 - P50,000) 100,000
* Jan. 1, 2011 - Dec. 31, 2017

Answer: B
 2. Cost of machine Y P525,000
Less: Accumulated depreciation, Dec. 31, 2017
(P525,000 x 4/12)
Carrying value, Dec. 31, 2017 175,000
Answer: A P350,000

3. Carrying value, Dec. 31, 2017 (see no. 2) P350,000

Less: Salvage Value 25,000
Remaining depreciable cost 325,000
Divide by revised remaining life — 4 yrs
Depreciation for 2018 P 81.250

Answer: C

4. Cost of building P3,000,000

Less: Accumulated depreciation, Dec. 31, 2017
(P3,000,000 x 3/20) 450,000
Book value of building, Dec 31, 2018 P2,550,000
5. Book value of building, Dec. 31, 2017 (see no. 4) P2,550,000
Less: Depreciation for 2016
(2,550,000 x 17/153*) 283,333
Book value of building, Dec. 31, 2018 2.2661667

SYD = Lx L+1/2 = 17 x 17+1/2 = 17 x 9 = 153

Answer: D

PROBLEM 10-8

HONDURAS, INC. has been using the FIFO method ofinventory costing since it began operations in 2017. In 2018,
the company decided to change to the weighted average method. The following are the December 31 inventory
baiances under each method.

FIFO Weighted Average

2017 P450,000 P560,000
2018 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

The audited income statement of URUGUAY CO. shows a net income of P 175,000 for the year
ended December 31, 2018. Adjustments were made for the following errors:

1. December 31, 2017, inventory overstated by P22,500.

2. December 31, 2018, inventory understated by P37,500.
1. 3. A P10,000 customers deposit received in December 2018, was credited to sales in 2018. The goods were actually
shipped in January 2019.
2.
What is the unadjusted net income of Uruguay Co. for the year ended December 31, 2018?
A. P234,OOO C. P170,OOO
B. P125,OOO D. P200,OOO

SOLUTION 10-9
Unadjusted net income (SQUEEZE) P 125,000
December 31, 2017, inventory — overstated 22,500
December 31, 2018, inventory — understated 37,500
Customer's deposit recognized as sales revenue Adjusted net income (10,000)
Adjusted net income P175,000

Answer: B

PROBLEM 10-10
The December 31 year-end financial statements of SAMOA COMPANY contained the following errors:
Dec. 31, 2017 Dec.31, 2018
Ending inventory P48,000 understated P40,500 overstated
Depreciation expense PI 1,500 understated

An insurance premium of P330,000 was prepaid in 2017 covering the years 2017, 2018, and 2019. The entire amount
was charged to expense in 2017. In addition, on December 31, 2018, a fully depreciated machinery was sold for P
75,000 cash, but the sale was not recorded until 2019. There were no other errors during 2017 and 2018, and no
corrections have been made for any of the errors. Ignore income tax effects

1. What is the total effect of the errors on Samoa's 2018 net income?
A. P123,500 overstatement
B. P27,500 overstatement
C. P 192,500 understatement
D. P 177,500 understatement

2. What is the total effect of the errors on the amount of Samoa's working capital at December 31, 2018?
A. P75,500 overstatement
B. P40,500 overstatement
C. P225,500 understatement
D. P 144,500 understatement
3. What is the total effect of the errors on the balance of Samoa's retained earnings at December 31, 2018?
A. P 156,000 understatement
B, P87,000 overstatement
C. P133,000 understatement
D. P85,000 understatement

SOLUTION 10-10
1. EFFECT OF ERRORS ON 2018 NET INCOME
Over- (Under-) statement
Understatement of 2017 ending inventory P 48,000
Overstatement of 2018 ending inventory 40,500
Prepaid insurance charged to expense in 2017
(P330,OOO/ 3) 110,000
Unrecorded sale of fully depreciated machinery in 2018 75,000
Total effect of errors on net income 123,500
Answer: A

2. EFFECT OF ERRORS ON WORKING CAPITAL AT DEC. 31, 2018

Over- (Under-) statement
Overstatement of 2018 ending inventory P 40,500
Prepaid insurance charged to expense in 2017 (110,000)
Unrecorded sale of fully depreciated machinery in 2018 (75,000)
Total effect on working capital (144,500)

Answer: D

3. EFFECT OF ERRORS ON RETAINED EARNINGS AT DEC. 31, 2018

Over- (Under-) statement

Overstatement of 2018 ending inventory P 40,500

Understatement of depreciation expense in 2017 11,500
Prepaid insurance charged to expense (110,000)
Unrecorded sale of fully depreciated machinery in 2018 (75,000)
Total effect on retained earnings (P133,000)

Answer: C

PROBLEM 10-11
The first audit of the financial statements of KIRIBATI CO. was made for the year ended December 31, 2018. In
reviewing the books, the auditor found out that certain adjustments had been overlooked at the end of 2017 and 2018.
He also discovered that other items had been improperly recorded. These omissions and other failures for each year are
summarized as follows:
December 31

2017 2018

Salaries payable 145,600 130,000

Interest receivable 43,200 35,500

Prepaid insurance 64,000 51,300

Advances from customers(l) 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 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 the expenditure is to be recognized at 5%.

Required:
Assuming that the nominal accounts for 2018 have not yet been closed into the income summary account, prepare all
the necessary adjusting journal entries on December 31, 2018.
SOLUTION 10-1 1
ADJUSTING JOURNAL ENTRIES
December 31, 2018

1. Retained earnings 145,600

Salaries expense 15,600
Salaries payable 130,000
2. Interest receivable 35,500
Interest income 7,700
Retained earnings 43,200
3. Prepaid insurance 51,300
Insurance expense 12,700
Retained earnings 64,000

4. Sales 15,100
Retained earnings 78.400
Advances from customers 93.500

5. Equipment (94,000 + 87,000) 181,000

Depreciation expense (9,400 + 4,350) 13,750
Accumulated depreciation – Equipment 18,450
Repairs expense 87,000
Retained earnings ( P94,000 – P4,700) 89,300

Computation of depreciation:
2017 94,000 x 5% = 4,700
2018 94,000 x 10% = 9,400
87,000 x 5% = 4,350
Total 18,450

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

2016
Jan. 1 Balance P81,000
Dec. 31 Net income for the year 18,000
2017
Jan. 10 Dividends paid P15,000
Mar. 6 Stock sold- excess over par 32,000
Dec. 31 Net loss for year 11,200
2018
Jan. 9 Dividends paid 15,000
Dec. 31 Balance 89,000
P131,000 P131,000

The audit of the December 31, 2018, financial statements of the company reveals the following:

a. Dividends declared on December 10, 2016 and 2017 had not been recorded in the books until paid.
b. Improvements in buildings and equipment of P9 600 had been charged to expense at the end of April 2015.
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 P 3,000 at the end of 2016, and by P4,300 at the
end of 2017.
d. Merchandise in transit and to which the company had title at December 31, 2017 and 2018 was not included in
the year-end inventories. These shipments of P3,800 and P5,500 were recorded as purchases in January of 2018
and 2019, respectively.
e. The company had failed to record sales commissions payable of P2,100 and P 1,700 at the end of 2017 and 2018,
respectively.
f. The company had failed to recognize supplies on hand of P 1,200 and P2,500 at the end of 2017 and 2018,
respectively.
g. The company reported a net loss of P 12,400 for the year ended December 31, 2018.

1. Prepare the necessary adjusting journal entries at December 31, 2018.

2. What is the corrected net loss of Antigua Corp. for the year ended December 31, 2018?
A. P7,6000 C. P6,000
B. P17,000 D. P16,200

SOLUTION 10-12
ADJUSTING JOURNAL ENTRIES
December 31, 2018

1. 1. Buildings and equipment 9,600

Depreciation expense (P9,600 x 1/8) 1,200
Accumulated depreciation 4,400
(P9,600/8 x 3 8/12)
Retained earnings 6,400

2. Cost of sales 4,300

Retained earnings 4,300
3. Inventory, Dec. 31, 2018 5,500
Accounts payable 5,500

4. Retained earnings 2,100

Sales commissions expense 2,100

5. Sales commissions expense 1,700

Sates commissions payable 1,700

6. Supplies expense 1,200

Retained earnings 1,200

7. Supplies on hand 2,500

Supplies expense 2,500

8. Retained earnings 32,000

Share premium 32,000

2. COMPUTATION OF CORRECTED NET INCOME (LOSS)

Reported net income (loss) P(12,400)
Omission of depreciation (1,200)
Understatement of physical inventory at Dec. 31, 2017 (4,300)
Overstatement of sales commissions expense
(2,100 - PI,700) 400
Overstatement of supplies expense (P2,500 - PI,200) 1,300
Corrected net income (loss) P(16,200)
Answer: D

PROBLEM 10-13
Analysis and Correction of Various Errors

NAURU CO. reported the following for the first two years of operations:
2016 - P735,000 net income
2017 - P925,000 net income

Early in 2018, the following errors were discovered:

1. Depreciation of building for 2016 was overstated by P85,000.

2, Depreciation of building for 2017 was understated by P 192,500.
3, December 31, 2016, inventory was understated by P 250,000.
4. December 31, 2017, inventory was overstated by

Required:
Prepare the necessary adjusting journal entries. Assume that the books are closed. Ignore income tax considerations.

SOLUTION 10-13
ADJUSTING JOURNAL ENTRIES
2018

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, 2016, inventory understatement. It is a counter-
balancing error.
4. Retained earnings 81,000
Inventory, Jan. 1, 2018 81,000

PROBLEM 10-14
Analysis and Correction of Various Errors

The following selected accounts are included in the trial balance of PALAU CORP. on December 31, 2018:

Debit Credit
Supplies on hand P135,000
Accrued salaries payable P75,000
Interest receivable 225,000
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, 2018, totaled P55,000.
2. The accountant failed to adjust the Accrued Salaries Payable account, Accrued salaries payable on December
31, 2018, totaled P220,000.
3. The Interest Receivable account was also left unadjusted at December 31, 2018. Accrued interest receivable on
December 31, 2018, amounted to P217,500.
4. The unexpired portions of the insurance policies totaled as of December 31, 2018.
5. A total of was received on January 1, 2018, for the rent of a building for both 2016 and 2019. The total amount
received was recognized as revenue in 2018.
6. The correct amount of depreciation for the year was but was erroneously recorded as P250,000.
7, Prior years' depreciation was understated by P360,000.

Required:
Prepare the necessary adjusting journal entries on December 31, 2018. Assume that the books have not been closed.

SOLUTION 10-14
ADJUSTING JOURNAL ENTRIES
December 31, 2018

1. Supplies expense 80,000

Supplies on hand 80,000
(P135,000 - P55,000)
2. Salaries expense 145,000
Accrued salaries payable 145,000
(220,000 - P75,000)
3. Interest income 37,500
Interest receivable 37,500
(255,000 - P217,500)
4. Insurance expense 1,250,000
Prepaid insurance 1,250,000
(P4,500,000 – P3,250,000)
5. Rental income 700,000
Unearned rent 700,000
P1,400,000/2)
6. Depreciation expense 2,250,000
Accumulated depreciation 2,250,000
(P2,500,000 - P250,000)
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 POHNPEI CORP. for the year ended December 31, 2018.
Your audit reveals the following situations:

1. Depreciation of P 16,000 for 2018 on equipment was not recorded.

2. The physical inventory count on December 31, 2017, 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, 2018, improperly included merchandise with a cost of
P42,500 that had been recorded as a sale on December 29, 2018, and held for the customer to pick up on
January 2, 2019.
4. A collection of P 28,000 on account from a customer received on December 31, 2018, was not recorded
until January 3, 2019.
5. In 2018, Pohnpei sold for P 18,500 fully depreciated equipment that originally cost P110,000. The
proceeds from the sale were credited to the Equipment account.
6. During December 2018, a competitor company filed a patent- infringement suit against Pohnpei
claiming damages of P 1,000,000. The company's legal counsel has indicated that an unfavorable
outcome is probable and a 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 2017 for trading purposes. No
valuation entry has been made. Information on cost and market value is as follows:
 Cost Market
December 31, 2017 P475,000 P475,000
December 31, 2018 P475,000 P500,000

8. At December 31, 2018, an analysis of payroll information shows accrued salaries of P61,000. The Accrued Salaries
Payable account had a balance of P80,000 at December 31, 2018, which was unchanged from its balance at
December 31, 2017.
9. A piece of equipment was acquired on January 2, 2018, 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 1, 2017, for a policy that expires on June 30, 2020, was charged to
Insurance Expense.
11. A patent was acquired at the beginning of 2017 for P250,000. No amortization has been recorded since its
acquisition. The patent had a 10-year useful life on the date of acquisition.

Required:
Prepare the necessary adjusting entries at December 31, 2018. Ignore income tax considerations.

SOLUTION 10-15
ADJUSTING JOURNAL ENTRIES
December 31, 2018

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 42,000

Inventory 42,000

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 600,000

Estimated litigation liability 600,000

7. Investment in trading securities 25,000

Unrealized holding gain on trading securities 25,000

Fair value, Dec. 31, 2018 P500,000

Fair value, Dec. 31, 2017 475,000
Increase in fair value P25,000

8. Accrued salaries payable 19,000

Salaries expense 19,000
(P80,000-P61,000)
 9. Depreciation expense (P160,000 / 8 yrs.) 20,000
Equipment 160,000
Repairs expense 160,000
Accumulated depreciation – equipment 20,000

10. Insurance expense (P75,000 / 3 yrs) 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, 2018, is presented below:
Suriname, Inc.
INCOME STATEMENT
For the Year Ended December 31, 2018

Sales P1,000,000
Cost of goods sold 600,000
Gross income 400,000
Operating expenses 150,000
Net Income P250,000

The December 31, 2018, audit of the company’s financial statements disclosed the following errors:
1. December 31, 2018, 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 2019, although the goods were shipped in December 2018,
and were excluded from the December 31 physical inventory.
4. Purchases of P30,000 made in December 2018, 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, 2018, and the proceeds were credited to the Sales account. The
machine was acquired on January 1, 2015, 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 2018.

1. Prepare the necessary adjusting journal entries on December 31, 2018.

2. What is the corrected net income for the year ended December 31, 2018?
a. P228,000 c. P258,000
b. P166,000 d. P224,000

SOLUTION 10-16
ADJUSTING JOURNAL ENTRIES
December 31, 2018

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
AJE 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 income of P505,000 and P387,000 for the years ended December 31, 2017 and 2018,
respectively. However, the auditor noted that the following errors had been made:

a. Sales for 2017 included amounts of P191,000 which had been received in cash during 2017, but for which
the related goods were shipped in 2018. Title did not pass to the buyer until 2018,
b. The inventory on December 31, 2017, was understated by P43,200.
c. The company’s accountant, in recording interest expense for both 2017 and 2018 on bonds payable, made
the following entry on an annual basis:
Interest expense 75,000
Cash 75,000
The bonds have a face value of P1,250,000 and pay a nominal interest rate of 6%. They were issued at a
discount of P75,000 on January 1, 2017, to yield an effective interest rate of 7%.
 d. Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2017 and 2018.
Repairs of P42,500 and P47,000 had been incurred in 2017 and 2018, 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 2017?

a. P303,200 c. P311,700
b. P225,300 d. P307,450
2. What is the corrected pretax income for 2018?
a. P488,992 c. P484,292
b. P480,042 d. P575,392

SOLUTION 10-17

1. Corrected pretax income for 2017 P311,700

Answer: C
2. Corrected pretax income for 2018 P488,992
Answer: A

2017 2018
Pretax income P505,000 P387,000
Sales revenue erroneously recognized in 2017 (191,000) 191,000
Understatement of 2017 ending inventory 43,200 (43,200)
Understatement of bond interest expense (1) (7,250) 7,250
Ordinary repairs erroneously capitalized (42,500) (47,000)
Overstatement of depreciation (2) 4,250 8,950
Corrected pretax income P311,700 P488,992

(1)
Discount
Year Book value of bonds Nominal interest Effective interest
amortization
P1,175,000 P75,000 P82,250 P7,250
2017
2018 1,182,250 75,000 82,758 7,758

(2)
Overstatement of depreciation
2017 (P42,500 / 10) P4,250
2018 (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 revenue have been handled on a cash basis by the inexperienced bookkeeper of the company.
Income statements prepared by the bookkeeper reported P145,000 net income for 2017 and P185,000 net income for
2018. 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, 2017. It was recorded as income at that time even
though the rental pertains to 2018.

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 where:
December 31, 2016 P5,500
December 31, 2017 7,500
December 31, 2018 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.
December 31, 2016 P6,500
December 31, 2017 3,700
December 31, 2018 7,100

1. What is the corrected net income for 2017?

A. P133,700 C. P146,700

B. P144,200 D. P139,300

2. What is the corrected net income for 2018?

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

Solution 10-18

1. Corrected net income for 2017 P133,700

Answer: A

2. Corrected net income for 2018 P197,700

Answer: B

2017 2018

Reported net income P145,000 P185,000

Unearned rent (6,500) 6,500

Unrecorded Salary Accruals:

Dec. 31, 2016 5,500
Dec. 31, 2017 (7,500) 7,500
Dec. 31, 2018 (4,700)
Supplies on hand not recognized:
Dec. 31, 2016 (6,500)
Dec. 31, 2017 3,700 (3,700)
Dec. 31, 2018 _________ 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 ben audited before. It has prepared the following comparative
financial statements for the years ended December 31, 2018 and 2017.

Senegal Co.

COMPARATIVE STATEMENTS OF FINANCIAL POSITION

December 31, 2018 and 2017

Assets 2018 2017

Current Assets:

Cash and cash equivalents P1,205,000 P 800,000

Accounts Receivable 1,960,000 1,480,000

Allowance for bad debts (185,000) (90,000)

Inventory 1,305,000 1,010,000

Total Current Assets 4,015,000 3,200,000

Noncurrent assets:

Property, plant, and equipment 835,000 847,500

Accumulated depreciation (608,000) (532,000)

Total noncurrent assets 227,000 315,500

Total assets P4,242,000 P3,515,500

Liabilities and Shareholder’s Equity

Liabilities:

Accounts Payable P 607,000 P 980,500

Shareholders’ equity:

Ordinary shares, P20 par value;

150,000 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 P3,515,000

Senegal Co.

COMPARATIVE INCOME STATEMENTS

For the Years Ended December 31, 2018 and 2017

2018 2017

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 2018 audit revealed the following facts:

a. On January 5, 2017, 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 1 ½ % of sales, beginning with 2018. (A charge of 2%
has already been made for 2018.)
c. Senegal uses the periodic inventory system. The following are the inventory errors for the last 2 years.
2017 – Ending inventory overstated by P75,500

2018 – Ending inventory overstated by P99,000

d. An equipment costing P150,000 was acquired on January 3, 2017. The purchase was recorded by a charge to
operating expense. The equipment has a useful life of 10 years and a residual value of P25,000. Senegal uses
the straight-line method in depreciating its assets.

Required:

1. Prepared the adjusting journal entries to correct the books at December 31, 2018. Assume that the books for
2018 have not yet been closed.
2. What is Senegal’s corrected net income for the year ended December 31, 2018?
A. P1,012,000 C. P786,600

B. P1,212,800 D. P1,061,800

3. What is Senegal’s corrected net income for the year ended December 31, 2018?
 A. P1,095,200 C. P1,082,800
B. P1,129,800 D. P1,107,800

Solution 10-19

ADJUSTING JOURNAL ENTRIES

December 31, 2018

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) 24,800

B. Allowance for bad debts 25,000

Bad Debt expense 25,000

(2% - 1 ½ % = ½ % 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 – P12,500) 137,500

Accumulated depreciation – Equipment 25,000
(P125,000 x 2/10)
2. Corrected net income for 2017 P1,061,800
Answer: D
3. Corrected net income for 2018 P1,082,800
Answer: C

COMPUTATION OF CORRECTED NET INCOME

2018 2017

Reported net income P1,100,000 P975,000

Prepaid insurance charged to expense (6,200) 24,800

Decrease in bad debt expense rate 25,000

Ending inventory – overstated:

2017 75,500 (75,500)

2018 (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, 2018, financial statements of TUNISIA COMPANY, you
discovered certain errors that had occurred during 2017 and 2018. No errors were corrected during 2017. The errors
are summarized below:

1. Beginning merchandise inventory (January 1, 2017) was understated by P259,200.

2. Merchandise costing P72,000 was sold for P120,000 to Naval Company on December 28, 2017, but the sale was
recorded in 2018. 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, 2017, for P172,800. The whole amount was charged
to Prepaid Insurance. No adjusting entry was prepared in 2017 and 2018.
4. A one-year note receivable of P288,000 was held by Tunisia beginning October 1, 2017. Payment of the 10%
note and accrued interest was received upon maturity. No adjusting entry was made on December 31, 2017.
5. Equipment with a 10-year life was purchased on January 1, 2017, for P1,176,000. No depreciation expense was
recorded during 2017 or 2018. Assume that the equipment has no residual value and that Tunisia uses the
straight-line method for recording depreciation.

Required:

Prepare journal entries to correct each of the errors described above. Assume that the nominal accounts for 2018 have
not yet been closed into the income summary account.

Solution 10-20

ADJUSTING JOURNAL ENTRIES

DECEMBER 31, 2018

1. No journal entry is necessary. The 2017 beginning inventory understatement is offset by the 2016 ending
inventory understatement. It is a counter-balancing error.

2. Sales 120,000
Retained Earnings 120,000

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
(P288,000 x 10% 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