Audit of Accounting Changes and Correction of Errors PDF

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CHAPTER 10Accounting Changes (Policies & Estimates) and Correction ofErrorsPROBLEM 10-Change in Accounting EstimateOn 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 usefu...

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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 Less: Accumulated depreciation, Dec. 31, 2017 (P600,000 x 40%) Book value, Jan 1, 2018 Less: Salvage value Depreciation for 2018

P600,000 240, 000 360,000 60,000 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-yearsdigits 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 B. Allowance for bad debts 29,600 Bad debt expense C. Bad debt expense 29,600 Allowance for bad debts D. Allowance for bad debts 29,600 Bad debt expense

29,600 29,600 29,600 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%) Add: .Debit balance of allowance Adjustment - increase in allowance

P27,600 2,000 P29,600

Answer: A

2. Cost of equipment Less: Accumulated depreciation, Dec. 31, 2017 (see computation below) Book value, Jan. 1, 2018 Divide by revised remaining life Revised annual depreciation

P1,100,000 962,500 P137,500 /10 yrs P 13,750

Answer: C Computation of Depreciation Expense – SYD METHOD Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Total

Depreciable Cost P1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x 1,100,000 x

Fraction 15/120 = 14/120 = 13/120 = 12/120 = 11/120 = 10/120 = 9/120 = 8/120 = 7/120 = 6/120 =

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

Depreciation P137,500 128,333 119,167 110,000 100,833 91,667 82,500 73,333 64,167 55,000 962,500

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-theyears'-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. B. C. D.

P18,000 36,000 16,200 16,200

P28,000 36,000 36,000 25,200

P40,000 36,000 36,000 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 (P90,000 x 90 % /5) 2016 (P50,000 x 90% /5) 2017 (P60,000 x 90% /5) Total Answer: D

2015 P16,000

P16,000

2016 P16,200 9,000 P25,200

2017 P16,200 9,000 10,800 P36,000

Total P48,600 18,000 10,800 P77,400

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 Less: Accum depreciation, Dec. 31, 2017 (P9,000 x 2) Book value, Jan. 1, 2018 Less: Salvage value (10% x P50,000) Remaining depreciable cost SYD rate 2017 acquisition: Cost Less: Accum. Depreciation, Dec. 31, 2017 Book value, Jan. 1, 2018 Less: Salvage value (10% x P60,000) Remaining depreciation cost SYD rate Depreciation expense in 2018

P50,000 18,000 32,000 5,000 27,000 x 3/6

P13,500

P60,000 10,000 49,200 6,000 43,200 x 4/10

17,280 52,380

Answer: C Computation of SYD rate: SYD = L x L+1 2

2015 acquisition 2016 acquisition 2017 acquisition

Remaining Life At Dec. 31, 2015 2 years 3 3 years 6 4 years 10

SYD

SYD Rate 2/3 3/6 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 Less: Salvage value Depreciable cost Divide by estimated useful life Annual depreciation

P800,000 50,000 750,000 /10yrs P75,000

Answer: B 2. REVISED ANNUAL DEPRECIATION Cost of equipment Less: Accumulated depreciation, Dec. 31, 2017 (P75,000 x 2) Book value, Jan. 1, 2018 Less: Revised salvage value Remaining depreciable cost Divide by revised useful life Revised annual depreciation

P800,000 150,000 650,000 60,000 590,000  4 yrs. 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. 2.

Prepare the entry to record bad debts expense for the year. What adjusting entry, if any, would be made to correct the inaccurate estimates for prior periods?

SOLUTION 10-5 1. Bad debt expense Allowance for bad debts (P950,OOO x 1%)

9,500 9,500

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 Less: Accumulated depreciation, Dec. 31, 2017 (P650,000 x 3/8) Book value, Jan 1, 2018

P650,000 243,750 406,250

Divide by revised life (10-3) Revised annual depreciation

/7yrs. 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. 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.

3.

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 B. P325,000

3. What is the depreciation expense on machine Y for 2018? A. P87,500 B. P77,083

C. P306,250 D. P525,000

C. P81,250 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 Accumulated depreciation — Machinery (P150,000 x 5*/15) Retained earnings (P150,000 - P50,000) * Jan. 1, 2011 - Dec. 31, 2017 Answer: B

150,000 50,000 100,000

2. Cost of machine Y

P525,000

Less: Accumulated depreciation, Dec. 31, 2017 (P525,000 x 4/12) Carrying value, Dec. 31, 2017 Answer: A 3.

Carrying value, Dec. 31, 2017 (see no. 2) Less: Salvage Value Remaining depreciable cost Divide by revised remaining life Depreciation for 2018

175,000 P350,000 P350,000 25,000 325,000 — 4 yrs P 81.250

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

P3,000,000 450,000 P2,550,000 P2,550,000 283,333 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. 2017 2018

FIFO P450,000 895,000

Weighted Average P560,000 999,000

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 Retained earnings (P560,000 - P450,000)

110,000 110,000

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.

3. A P10,000 customers deposit received in December 2018, was credited to sales in 2018. The goods were actually shipped in January 2019. 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) December 31, 2017, inventory — overstated December 31, 2018, inventory — understated Customer's deposit recognized as sales revenue Adjusted net income Adjusted net income

P 125,000 22,500 37,500 (10,000) 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 Understatement of 2017 ending inventory Overstatement of 2018 ending inventory Prepaid insurance charged to expense in 2017 (P330,OOO/ 3) Unrecorded sale of fully depreciated machinery in 2018 Total effect of errors on net income

Over- (Under-) statement P 48,000 40,500 110,000 75,000 123,500

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 Understatement of depreciation expense in 2017 Prepaid insurance charged to expense Unrecorded sale of fully depreciated machinery in 2018 Total effect on retained earnings

P 40,500 11,500 (110,000) (75,000) (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

Salaries payable

2017

2018

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 Salaries expense Salaries payable Interest receivable Interest income Retained earnings Prepaid insurance Insurance expense Retained earnings

2.

3.

4.

145,600 15,600 130,000 35,500 7,700 43,200 51,300 12,700 64,000

Sales Retained earnings Advances from customers

5.

15,100 78.400 93.500

Equipment (94,000 + 87,000) Depreciation expense (9,400 + 4,350) Accumulated depreciation – Equipment Repairs expense R...