ANALYSIS AND CORRECTION OF ERRORS

AUDITING PROBLEMS

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

When the records of ABC Company were reviewed at the close of 2017, the errors listed below
were discovered.

For each item, indicate the effects of each of the following errors by writing O foroverstatement,
U for understatement, and X for no effect in the appropriate column.

2017 2018
NI Asset Liability RE, NI Asset Liability RE,
after 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
2017.
b. Sale of merchandise on account on December 30, 2017 amounting to P20,000 was not
recorded until the customer paid his account in January 2018.
c. Depreciation expense on equipment in 2017 was overstated by P10,000.
d. Paid one-year insurance premium of P24,000 effective April 1, 2017. The entire amount was
debited to expense account and no adjustment was made at the end of 2017.
e. On December 31, 2017, 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.
f. Failure to record supplies on hand at the end of 2017. The supplies on hand amounted to
P5,000.
g. Understatement of 2017 ending inventory worth P24,000.
h. Failure to record accrued interest on notes payable at the end of 2017. Notes Payable,
principal amount, P100,000;interest rate, 10%;Acquired March 31, 2017
i. Failure to recognized unearned rent at the end of 2017 worth 12,000.
j. Goods received in December 2017 were recorded as purchases when paid 2018. The goods
were excluded from the 2017 ending inventory.
Problem 1-2 Effect Errors on Net Income, Retained Earnings and Working Capital
The income statement of ABC Inc. showed the following net income:
2016 P1,750,000 2017 P2,000,000

An examination of the accounting records for the year ended December 31, 2017 revealed that
several errors were made. The following errors were discovered:

a. Salary accrued at year-end were consistently omitted:

2016 P100,000 2017 140,000
b. The footings and extensions showed that the inventory on December 31, 2016 was overstated
by P190,000.
c. Prepaid insurance of P120,000 applicable to 2018 was expensed in 2017.
d. Interest receivable of P20,000 was not recorded on December 31, 2017.
e. On December 26, 2017 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 2017.
f. A building which had a fair value of P1,200,000 was accepted from the city government as a
donation on January 1, 2016. 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 2016 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 depreciated over remaining
life using straight line.

Required:
1. How much is the correct net income in 2016?
2. How much is the correct net income in 2017?
3. How much is retroactive adjustment to the 2018 beginning retained earnings?
4. How much is the net effect of the errors to the 2017 working capital?
5. How much is the correct carrying value of the building as of December 31, 2017?

Problem 1-3 Effect Errors on Net Income

The income statement of ABC Company for the years ended December 2015, 2016, and 2017
indicate the following net income:

2015 170,000 2016 205,000 2017 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 2016.
b. Goods costing P 8,000 were in transit from a supplier on December 31, 2015. 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:
2015 P10,000 2016 P14,000 2017 P16,000
d. The merchandise inventory at December 31, 2016 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 2016 was expensed in 2015.
f. Interest receivable of P2,400 was not recorded on December 31, 2016.
g. On January 2, 2016, 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 2016. In addition, depreciation was recorded for this equipment in both
2016 and 2017 at the rate of 10% of cost.

Required: Compute the adjusted net income from 2015 to 2017.

Problem 1-4Effect Errors on Net Income, Retained Earnings and Working Capital
You are auditing the financial statement of ABC 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 2016 and 2017 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 2016 and 2017.
These omission and other errors for each year were summarized as follows:

12/31/2017 12/31/2016
Accrued Salaries P780,000 P873,600
Accrued Interests Income 213,000 259,200
Prepaid Insurance 307,800 384,000
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) 561,000 470,400
Machinery (Capital expenditures had been recorded 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%.) 522,000 564,000

Required:Based on the above data and the result of your audit, provide the following:
1. How much is the total effect of the errors on the 2016 net income?
2. How much is the total effect of the errors on the 2017 net income?
3. How much is the total effect of the errors on the balance of the company’s retained earnings
at December 31, 2017?
4. How much is the total effect of the errors on the company’s working capital at December 31,
2017?
5. The necessary adjusting journal entry for the error in recording capital expenditures on
Machinery as of December 31, 2016.