UNIT 1

ANALYSIS AND CORRECTION OF ERRORS

Estimated Time: 2.5 HOURS

Discussion questions 1-1

1. Define the following terms:

a. Reclassifying entry
b. Correcting entry
c. Adjusting entry
2. What do books still open and books already closed mean? What is the impact of
each on reclassifying, correcting, and adjusting entries?
3. What are prior period errors? Explain the treatment of prior period errors and provide
two examples.
4. Differentiate counterbalancing and non-counterbalancing errors. Provide two
examples each.

Problem 1-1 Effect of Counterbalancing and Non-counterbalancing Errors

When the records of Magcale Company were reviewed at the close of 2014, the errors
listed below were discovered.
For each item, indicate the effects of each of the following errors by writing O for
overstatement, U for understatement, and X for no effect in the appropriate column.
NI

Asset

2014
Liability

RE,
RE,
before
after
closing closing

NI

Asset

2015
Liability

RE,
RE,
before
after
closing closing

A
B
C
D
E
F
G
H
I
J
a. The company failed to record purchases of merchandise on account of P25,000
at the end of 2014.
b. Sale of merchandise on account on December 30, 2014 amounting to P20,000
was not recorded until the customer paid his account in January 2015.
c. Depreciation expense on equipment in 2014 was overstated by P10,000.
d. Paid one-year insurance premium of P24,000 effective April 1, 2014. The entire
amount was debited to expense account and no adjustment was made at the end
of 2014.
e. On December 31, 2014, the Company acquired a parcel of land and a building at
a total cost of P500,000. The entire amount paid was debited to the land account.
A reasonable estimate of the cost that should have been allocated to the building
was P200,000. The building has an estimated life of 20 years.
Auditing Practice I
Workbook

Third Term, AY 2014-2015

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f.

Failure to record supplies on hand at the end of 2014. The supplies on hand
amounted to P5,000.
g. Understatement of 2014 ending inventory worth P24,000.
h. Failure to record accrued interest on notes payable at the end of 2014. Notes
Payable, principal amount, P100,000;interest rate, 10%;Acquired March 31, 2014
i. Failure to recognized unearned rent at the end of 2014 worth 12,000.
j. Goods received in December 2014 were recorded as purchases when paid 2015.
The goods were excluded from the 2014 ending inventory.

Problem 1-2 Effect Errors on Net Income, Retained Earnings and Working Capital
The income statement of Binsol Inc. showed the following net income:
2014 P1,750,000
2015
P2,000,000

An examination of the accounting records for the year ended December 31, 2015
revealed that several errors were made. The following errors were discovered:
a. Salary accrued at year-end were consistently omitted:
2014 P100,000
2015
140,000
b. The footings and extensions showed that the inventory on December 31, 2014 was
overstated by P190,000.
c. Prepaid insurance of P120,000 applicable to 2016 was expensed in 2015.
d. Interest receivable of P20,000 was not recorded on December 31, 2015.
e. On December 26, 2015 an equipment costing P400,000 was sold for P220,000. At
the date of sale, the equipment had an accumulated depreciation of P240,000. The
cash received was recorded as miscellaneous income in 2015.
f. A building which had a fair value of P1,200,000 was accepted from the city
government as a donation on January 1, 2014. The building that was estimated to be
useful for another 10 years was to be used as a factory site as a condition on the
grant. Legal fees incurred in relation to the donation was at P100,000 and was
charged to 2014 operating expenses. Another P200,000 was incurred to remodel and
renovate the building prior to use. The building was capitalized at P200,000
(renovation cost) and was depreciation over remaining life using straight line.
Required:
1. What is the correct net income in 2014?
2. What is the correct net income in 2015?
3. What is retroactive adjustment to the 2016 beginning retained earnings?
4. What is the net effect of the errors to the 2015 working capital?
5. What is the correct carrying value of the building as of December 31, 2015?

Problem 1-3 Effect Errors on Net Income

The income statement of Jerusalem Company for the years ended December 2013,
2014, and 2015 indicate the following net income:
2013

170,000

2014

205,000

2015

186,000

An examination of the accounting records for these years indicates that several errors
were made in arriving at the net income amounts reported. The following errors were
discovered:
a. Sale of merchandise on account amounting to P 15,000 was not recorded at the end
of 2014.
Auditing Practice I
Workbook

Third Term, AY 2014-2015

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b. Goods costing P 8,000 were in transit from a supplier on December 31, 2013. The
goods were appropriately included in the ending inventory but the corresponding
purchase was not recorded.
c. Accrued salaries were consistently omitted from the records. The amounts omitted
were:
2013 P10,000
2014 P14,000
2015 P16,000
d. The merchandise inventory at December 31, 2014 was understated by P 9,000 as
the result of errors made in the footings and extensions on the inventory sheets.
e. Unexpired insurance of P 12,000 applicable to 2014 was expensed in 2013.
f. Interest receivable of P2,400 was not recorded on December 31, 2014.
g. On January 2, 2014, a piece of equipment costing P40,000 was sold for P18,000. At
the date of sale, the equipment had an accumulated depreciation of P24,000. The
cash received was recorded as income in 2014. In addition, depreciation was
recorded for this equipment in both 2014 and 2015 at the rate of 10% of cost.
Required:
Compute the adjusted net income from 2013 to 2015.

Problem 1-4 Effect Errors on Net Income, Retained Earnings and Working Capital

You are auditing the financial statement of Platon Company for the first time. You have
discovered that the merchandise inventory at the end of each year was understated by
P100,000 and P200,000 in 2013 and 2014 respectively.
In addition, in inspecting the record of the company, you discovered that some items had
been improperly recorded and that certain year-end adjustments had been overlooked in
2013 and 2014. These omission and other errors for each summarized as follows:
Accrued Salaries
Accrued Interests Income
Prepaid Insurance
Advances from Customers
(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)
Machinery (Capital expenditures had been records as repairs
but should have been charged to Machinery; the depreciation
rate is 10% per year, but depreciation in the year of
expenditure is to be recognized at 5%.)

12/31/2014
P780,000
213,000
307,800

12/31/2013
P873,600
259,200
384,000

561,000

470,400

522,000

564,000

Required:
Based on the above data and the result of your audit, provide the following:
1. What is the total effect of the errors on the 2013 net income?
2. What is the total effect of the errors on the 2014 net income?
3. What is the total effect of the errors on the balance of the companys retained
earnings at December 31, 2014?
4. What is the effect of the 2013 errors in the 2014 net income?
5. What is the total effect of the errors on the companys working capital at December
31, 2014?
6. The necessary adjusting journal entry for the error in recording capital expenditures
on Machinery as of December 31, 2013.
Auditing Practice I
Workbook

Third Term, AY 2014-2015

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