CHAPTER 19 19-1 COMPREHENSIVE AUDIT OF BALANCE SHEET AND INCOME STATEMENT ACCOUNTS Daffodil, Inc Adjusting Journal Entries 12.31.07 AJE (1) (2) Share donation Treasury shares Land Building 35,000 10,000 15,000 Accumulated depreciation - machinery Loss on sale of machinery Machinery Cost Less: AD (20%) NBV Proceeds Loss (3) 60,000 1,000 2,000 3,000 P 5,000 1,000 P 4,000 2,000 P 2,000 (a) Accumulated depreciation - building Retained earnings (b) Factory operating expenses Accumulated depreciation - building Accumulated depreciation - machinery Building (P315,000 x 2%) Machinery: 5,000 x 10% = 145,000 x 10% = (4) 300 300 21,300 6,300 15,000 P 500 14,500 P15,000 Merchandise inventory, 12.31.07 B/S Merchandise inventory, 12.31.07 I/S 175,000 175,000 19-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition (5) (6) (7) (8) (9) Administrative expenses Allowance for doubtful accounts 1,000 Factory operating expenses Unexpired insurance 3,000 Retained earnings Bond interest expense Unamortized bond discount 2,500 2,500 Sinking fund assets First Mortgage SF Bonds Sinking fund assets Sinking fund income 1,000 3,000 5,000 23,500 23,500 1,500 1,500 Comprehensive Audit of Balance Sheet and Income Statement Accounts 19-1 19-3 Daffodil, Inc (continued) Daffodil, Inc Working Trial Balance 12.31.07 Cash Accounts receivable Provision for doubtful accounts Inventories, 12.31.06 Unexpired insurance, 12.31.06 Land Buildings Accumulated Depreciation - Buildings Machinery Accumulated Depreciation - Machinery Sinking fund assets Unamortized bond discount Treasury shares, ordinary Accounts payable Bond interest accrued 1st Mortgage, 6% SF Bonds Ordinary shares Premium on ordinary shares Share donation Retained earnings, 12.31.06 Sales Purchases Payroll Factory operating expenses Trial Balance Dr Cr P 64,000 200,000 P 1,000 223,000 6,000 220,000 330,000 6,600 148,000 15,000 25,000 Adjustments Dr 283,500 169,000 121,500 (3a) (2) (8) (9) 300 1,000 23,500 1,500 (1) (7) 60,000 2,500 35,000 Bond interest expense 15,000 (7) 2,500 (2) (4) 2,000 175,000 3,000 10,000 15,000 6,300 3,000 15,000 (7) (1) 5,000 35,000 (8) 23,500 (3a) 3,000 210,000 315,000 12,600 145,000 29,000 50,000 20,000 88,000 3,750 250,000 500,000 50,000 71,950 300 21,300 3,000 1,000 145,800 36,000 17,500 P1,900,000 P 293,600 Net Income (6) (1) (1) (3b) (2) (3b) P 875,000 Administrative expenses P1,900,000 1,000 283,500 169,000 (3b) (6) (5) Loss on sale of machinery Merchandise inventory 12.31.07 Sinking fund income (5) Balance Sheet Dr Cr P 64,000 200,000 P 2,000 P 223,000 25,000 35,000 88,000 3,750 226,500 500,000 50,000 60,000 74,150 875,000 Income Statement Dr Cr Cr 2,000 (4) (9) 175,000 1,500 P 293,600 175,000 1,500 175,000 P 876,800 174,700 P1,051,500 P1,182,000 P1,007,300 174,700 P1,051,500 P1,051,500 P1,182,000 P1,182,000 19-4 Solutions Manual to Accompany Applied Auditing, 2002 Edition 19-2 Part I Adjusting Journal Entries, 12-31-05 AJE (1) Depreciation expense Accumulated depreciation 1,778 1,778 [(P22,000 – P2,000) – P4,000] (2) (3) (4) (5) (6) (7) (8) (9) Prepaid interest Retained earnings Interest expense Merchandise inventory, 12-31-07, BS Merchandise inventory, 12-31-07, IS or Cost of Sales 3,100 1,900 15,000 15,000 Retained Earnings Purchases 6,000 Prepaid insurance Insurance expense 3,000 Store supplies inventory Store supplies expense Retained earnings 1,450 6,000 3,000 550 900 Retained earnings Commissions expense Accrued commissions payable 730 240 Cash in bank Miscellaneous income 650 Purchases Accounts payable 800 (10) Income from Investment Investment (11) Prepaid advertising and promotions Advertising and promotions expense (12) 5,000 970 650 800 3,000 3,000 90,000 90,000 NO AJE (13) Machinery Depreciation expense – machinery Allowance for depreciation – machinery Repairs and maintenance 20,000 167 167 20,000 Comprehensive Audit of Balance Sheet and Income Statement Accounts (14) Miscellaneous income Gain on sale of treasury shares Land Additional paid-in capital arising from Treasury Share transactions 2,000 5,000 (15) Doubtful accounts expense Allowance for uncollectible accounts 14,500 Required allowance as of 12-31-07 – on past due accounts (5% x P30,000) – on current accounts (1% x P400,000) Total Unadjusted debit balance of the “Allowance” account Additional Provision 19-5 2,000 5,000 14,500 P 1,500 4,000 P 5,500 9,000 P14,500 Part II Column B – Adjustment, 12-31-07 AJE (a) Retained earnings Purchases xx (b) NONE xx (c) Retained Earnings Allowance for depreciation xx Retained Earnings Allowance for depreciation xx Machinery Retained earnings xx Depreciation Allowance for depreciation xx Retained earnings Taxes xx xx xx (d) (e) (f) (g) 19-3 xx xx xx xx xx International Company AJE (1) (2) Depreciation expense Accumulated depreciation – delivery vehicle Cost of sales Retained earnings 3,200 3,200 19,000 19,000 19-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition (3) (4) (5) (6) (7) (8) (9) Cost of sales Inventory 8,500 Cash Accounts receivable 5,600 Accumulated depreciation – equipment Equipment Gain on sale of equipment Estimated litigation loss Estimated litigation liability 8,500 5,600 22,000 18,300 3,700 125,000 125,00 Unrealized holding gain or loss – Income Allowance for decline in value of securities 2,000 Accrued salaries payable Salaries expense 3,800 Depreciation expense Equipment Repairs expense Accumulated depreciation – equipment (10) Insurance expense Prepaid insurance Retained earnings 2,000 3,800 4,000 32,000 32,000 4,000 5,000 7,000 12,500 (11) No adjusting entry Trademark has indefinite life and no amortization need be made 19-4 Sunshine Cosmetics, Inc Requirement (1) AJE (1) (2) (3) Inventory, Dec 31, 2006 (BS) Inventory, Dec 31, 2006 (IS) or Cost of sales 67,200 Doubtful accounts expense Allowance for doubtful accounts (15,660 – 740) 14,920 Accounts payable Purchase returns and allowances 20,760 67,200 14,920 20,760 Comprehensive Audit of Balance Sheet and Income Statement Accounts (4) (5) (6) (7) (8) (9) Sales commissions Accrued commissions payable 19-7 216 216 Freight-in Accounts payable 1,600 Advertising expense Prepaid advertising 1,212 Freight-out or Expense Sales 8,400 Interest receivable Interest income 1,380 Depreciation expense Accumulated depreciation 1,300 1,600 1,212 8,400 1,380 1,300 (10) Supplies expense Unused Supplies 1,160 1,160 (11) Provision for Income tax expense Income tax payable 107,386 107,38 Requirement (2) Sunshine Cosmetics, Inc Income Statement For the Year Ended December 31, 2006 Revenue from sales: Sales Less: Sales returns and and allowances Sales discounts Cost of goods sold: Inventory, January Net purchases: Purchases Less purchase returns and allowances Freight-in Cost of goods available for sale Less Inventory, December 31 Gross profit on sales P998,800 (a) P 22,400 1,760 24,160 P974,640 P179,400 P346,000 20,760 (c) 325,240 12,650 (b) P517,290 108,300 (d) 408,990 P565,650 19-8 Solutions Manual to Accompany Applied Auditing, 2006 Edition Other income: Interest revenue Dividend revenue Gain on sale of assets Total income Operating expenses: Selling expenses: Sales salaries and commissions Advertising expense Depreciation expense – Sales/delivery equipment Freight expense Travel expense – sales representatives Miscellaneous selling expenses General and administrative expenses: Legal services Insurance and licenses Depreciation expense – office equipment Utilities Telephone and postage Supplies expense Officers’ salaries Doubtful accounts expense Total operating expenses Other expense and losses: Interest expense Loss on sale of equipment Income from continuing operations before income taxes Income taxes Income from continuing operations Discontinued operations: Gain from discontinued operations (net of income taxes of P25,600) Net income P 2,780 (i) 14,300 37,000 54,080 P619,730 P 70,216 (e) 33,392 (f) 13,500 (g) 8,400 9,120 4,400 P139,028 P 4,450 17,000 9,600 12,800 2,950 1,160 (k) 73,200 14,920 (h) 136,080 (275,108) P 9,040 45,200 (54,240) P290,382 92,922 (j) P197,460 54,400 P251,860 Comprehensive Audit of Balance Sheet and Income Statement Accounts Earnings per ordinary share: Income from continuing operations (P197,460  78,000 shares) Gain from discontinued operations (P54,400  78,000 shares) Net income (P251,860  78,000 shares) 19-9 P2.53 0.70 P3.23 Computations: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) Sales: P990,400 + P8,400 = P998,800 Freight-in: P11,050 + P1,600 = P12,650 Purchase returns and allowances: P346,000 x 6% = P20,760 Inventory: P41,100 + P67,200 = P108,300 Sales salaries and commissions: P70,000 + (P7,200 x 3%) = P70,216 Advertising expense: P32,180 + (P3,636 x 2/6) = P33,392 Depreciation expense: P12,200 + (P15,600 x 10/120) = P13,500 Doubtful accounts expense: (P522,000 x 3%) – P740 = P14,920 Interest revenue: P1,400 + P1,380 = P2,780 Income taxes: P335,582 x 32% = P107,387 Supplies expense: P4,360 – P3,200 = P1,160 Sunshine Cosmetics, Inc Retained Earnings Statement For the Year Ended December 31, 2006 Retained earnings, January Add net income per income statement P 881,340 251,860 P1,133,200 66,000 P1,067,200 Deduct dividends paid Retained earnings, December 31 19-5 Del Bakery Working papers are not required, but they facilitate the preparation of a corrected balance sheet Del Bakery Working Papers for Corrected Balance Sheet December 31, 2007 Account Title Current Assets Current Liabilities Other Assets Other Liabilities Investment in Business Balance Sheet Debit Credit 53,415 29,000 75,120 3,600 95,935 Corrections Debit Credit (a) 53,415 (c) 29,000 (b) 75,120 (d) 3,600 (e) 95,935 Corrected Balance Sheet Debit Credit 19-10 Solutions Manual to Accompany Applied Auditing, 2006 Edition Cash Investment Securities – trading (at market value) Trade Accounts Receivable Inventory Supplies Inventory Delivery Truck Fixtures Accumulated Depreciation – Fixtures Cash Surrender Value of Insurance on Officers’ Lives Retained Earnings Land Buildings Accumulated Depreciation – Buildings [2 ½ (P62,000  20)] 11% Mortgage Payable 11% Mortgage Payable (current portion) Interest Payable Trade Accounts Payable Miscellaneous Liabilities Share Capital, P5 stated value, 5,000 shares Paid-in Capital from Sale of Shares at More Than Stated Value Corrections: (a) (b) (c) 128,535 128,535 (a) 10,600 10,600 (a) (a) (a) (a) (a) (a) 2,575 12,500 8,040 425 2,100 12,500 (a) 2,100 2,100 (a) 4,100 (a) 2,675 (b) 7,750 (d) 350 4,100 30,160 (b) 30,000 (b) 62,000 (e) 40,935 30,000 62,000 (b) 7,750 (b) 12,000 7,750 12,000 (b) 4,000 (b) 880 (c) 29,000 (d) 3,950 4,000 880 29,000 3,950 (e) 25,000 25,000 284,150 (e) 30,000 284,150 144,840 30,000 144,840 To restate current assets To restate other assets To restate current liabilities 2,575 12,500 8,040 425 2,100 12,500 (d) (e) To restate other liabilities To restate owners’ equity accounts Del Bakery Corrected Balance Sheet December 31, 2007 Assets Current assets: Cash P10,600 Investment securities – trading (reported at market; cost P4,250) Trade accounts receivable (fully collectible) Inventory 2,575 12,500 8,040 19-12 Solutions Manual to Accompany Applied Auditing, 2006 Edition (3) (4) (5) (6) (7) (8) (9) Bank loan payable Other expenses Cash Cash Accounts receivable 400,000 12,500 412,500 75,000 75,000 Operating expenses Cash 1,500 Cash Other income 16,000 Accounts receivable – others (2,000 + 3,000) Operating expenses Cash 1,500 16,000 5,000 2,000 7,000 Marketable securities Other income 40,000 Other income Marketable securities 54,000 (10) Marketable securities Other income (10.a) Valuation allowance – Marketable securities – Trading Other income – Unrealized holding gain 40,000 54,000 32,000 32,000 145,600 145,600 (11) Sales Accounts receivable 500,000 (12) Inventory Cost of sales 400,000 500,000 400,000 (13) Accounts receivable – others (30,000 – 15,000) Accounts receivable 15,000 (14) Accounts receivable – others Accounts receivable 55,000 (15) Accounts receivable Other current liabilities 50,000 (16) Operating expenses Allowance for doubtful accounts 21,900 15,000 55,000 50,000 21,900 Comprehensive Audit of Balance Sheet and Income Statement Accounts (17) Other income Discount on notes receivable (18) Discount on notes receivable Other income 54,545 54,545 4,545 4,545 (19) Cost of sales Accounts payable 60,000 (20) Cost of sales Accounts payable 25,000 (21) Inventory Cost of sales 25,000 (22) Accounts receivable – others Inventory 16,000 (23) Sales Accounts receivable 13,000 (24) Operating expenses Prepaid expenses 46,250 (25) Operating expenses Prepaid expenses 5,000 (26) Other assets Operating expense Prepaid expenses 60,000 120,000 60,000 25,000 25,000 16,000 13,000 46,250 5,000 180,000 (27) Long-term bond investment Other income 5,777 (28) Accounts receivable – others Other income 5,333 (29) Land Building 5,777 5,333 1,062,50 3,187,50 Land and building (30) Building Land and building 19-13 4,250,00 425,000 425,000 19-14 Solutions Manual to Accompany Applied Auditing, 2006 Edition (31) Operating expenses Land and building 20,000 (32) Operating expenses Prepaid expenses Land and building 27,500 27,500 20,000 55,000 (33) Land and building Operating expenses Accumulated depreciation – building 237,500 115,578 121,922 (34) Prepaid expenses Operating expenses Equipment 10,000 10,000 (35) Operating expenses Accumulated depreciation – equipment 55,400 (36) Accounts payable Other current liabilities 50,000 (37) Operating expenses Estimated liability on warranties 15,000 (38) Other current liabilities Other expenses 50,000 20,000 55,400 50,000 15,000 50,000 (39) Income taxes payable Provision for income tax 115,290 115,290 MASIPAG CORPORATION Balance Sheet December 31, 2007 Assets Current assets Cash Marketable securities Valuation allowance Accounts receivable Allowance for doubtful accounts Notes receivable Discount on notes receivable Accounts receivable – others P P 400,000 145,600 P 442,000 (33,150) P 600,000 (50,000) 734,000 545,600 408,850 550,000 96,333 Comprehensive Audit of Balance Sheet and Income Statement Accounts Inventory, December 31, 2007 Prepaid expenses Total current assets Investments Long-term bond investment Property, plant and equipment Land Building Accumulated depreciation – Building Equipment Accumulated depreciation – Equipment 19-15 1,960,500 175,250 P4,470,533 744,077 P1,062,500 P3,612,500 (121,922) 3,490,578 P1,654,000 (235,400) 1,418,600 Total property, plant and equipment Other assets Total assets 5,971,678 110,000 P11,296,288 Liabilities and Shareholders’ Equity Current liabilities Accounts payable Bank loan payable Accrued expenses payable Other current liabilities Income taxes payable Estimated liability on warranties Total current liabilities Shareholders’ equity Ordinary shares Additional paid-in capital Retained Earnings Total shareholders’ equity Total liabilities and shareholders’ equity P 877,000 1,100,000 59,000 100,000 130,558 70,000 P 2,336,558 P5,000,000 1,655,250 2,304,480 8,959,730 P11,296,288 MASIPAG CORPORATION Income Statement For the Year Ended December 31, 2007 Sales Cost of sales Gross profit Other income Operating expenses Other expenses Income before taxes Provision for income tax Net Income 19-7 Felicity Company P 6,437,000 (4,060,000) P 2,377,000 225,710 (1,511,509) (37,500) P 1,053,701 (342,441) P 711,260 19-16 Solutions Manual to Accompany Applied Auditing, 2006 Edition Adjusting Journal Entries, Dec 31, 2007 AJE (1) (2) (3) (4) (5) (6) (7) (8) (9) Cash Prepaid interest Other charges Long-term debt (current portion) Long-term debt Cash Accounts payable and others 31,000 3,000 2,000 24,000 12,000 2,000 2,000 Investments in SMC shares – available for sale (non-current) Marketable securities 72,000 Unrealized loss due to decline in value of non-current investment (equity) Operating expenses 20,000 Allowance for doubtful accounts Operating expenses Accounts receivable Operating expenses 72,000 20,000 41,100 41,100 8,000 8,000 Inventory Cost of sales 12,000 Sales Accounts receivable 14,400 Revaluation increment Accumulated depreciation Property and equipment 12,000 14,400 120,000 80,000 200,000 (10) Accumulated depreciation Operating expenses 36,000 (11) Operating expenses Accumulated depreciation 48,000 (12) Revaluation increment Retained earnings 24,000 (13) Property and equipment 30,000 36,000 48,000 24,000 Comprehensive Audit of Balance Sheet and Income Statement Accounts Operating expenses 19-17 30,000 (14) Retained earnings Cumulative effect of change in accounting principle 13,000 (15) Accounts receivable – others Cash 22,000 (16) Provision for income tax Income tax payable 25,445 13,000 22,000 25,445 FELICITY COMPANY Balance Sheet December 31, 2007 Assets Current Assets: Cash Accounts receivable Allowance for doubtful accounts Accounts receivable -others Inventories Prepaid interest Non-current Assets: Advances to affiliate Investments in SMC shares – available for sale Allowance for decline in value of non-current investment Property and equipment Accumulated depreciation (1,172,000) Total Assets P 123,600 1,751,820 (27,000) 62,000 262,000 3,000 48,000 72,000 (20,000) 2,600,000 P 3,703,420 Liabilities and Shareholders’ Equity Accounts payable and others (including current portion of bank loan of P24,000) Income tax payable Long-term debt Ordinary share capital Retained earnings Unrealized loss due to decline in value of investment in SMC Revaluation increment Total Liabilities and Shareholders’ Equity P 434,616 100,205 72,000 2,042,000 978,599 (20,000) 96,000 P 3,703,420 19-18 Solutions Manual to Accompany Applied Auditing, 2006 Edition FELICITY COMPANY Income Statement For the Year Ended December 31, 2007 Sales Cost of sales Gross profit Operating expenses Other charges Income from continuing operations before tax Provision for income tax (35%) Income from continuing operations after tax Discontinued operations (net) (6,500) Net income 19-8 P 2,757,124 2,257,604 P 499,520 (83,522) (102,000) P 313,998 109,899 P 204,099 P 197,599 Learn Company Condensed Comparative Income Statements Construction revenue Construction expense Other expenses Income before income taxes Income tax expense Net income 2009 2008 2007 P900,000 (420,000) (80,000) P400,000 (120,000) P280,000 P420,000 (182,000) (70,000) P168,000 (50,400) P117,600 P200,000 (80,000) (50,000) P 70,000 (21,000) P 49,000 Comparative Statements of Retained Earnings Balance at beginning of year, as previously reported Add: Adjustment for the cumulative effect on prior years of applying retroactively the new method of accounting for long-term contracts (net of income taxes) Balance at beginning of year, as adjusted 2009 2008 P 77,000 P 7,000 89,600 P166,600 b 42,000 P 49,000 2007 P a 0 P Comprehensive Audit of Balance Sheet and Income Statement Accounts Net income Balance at end of year 19-19 280,000 117,600 49,000 P446,600 P166,600 P 49,000 Note: The company has accounted for revenue and costs for long-term construction contracts by the percentage-of-completion method in 2009, whereas in prior years revenues and costs were determined by the completed-contract method The new method of accounting for long-term contracts was adopted to (state justification for change in accounting principle) and financial statements of prior years have been restated to apply the new method retroactively The effect of the accounting change on income of 2009 and on income as previously reported in 2007 and 2008 is as follows: Net income Earnings per ordinary share 2009 P112,000 P11.20 c Increase 2008 P47,600 P4.76 2007 P42,000 P4.20 The balances of retained earnings for 2008 and 2009 have been adjusted for the after-tax effect of applying the new method of accounting retroactively a P49,000 – P7,000 b (P49,000 + P117,600) – (P7,000 + P70,000) c 19-9 P280,000 – [(P600,000 – P280,000 – P80,000) x (1 – 0.30)] Goody Construction Company Requirement (1) 2007 Jan Construction in Progress Retained Earnings [P70,000 x (1 – 0.30)] Deferred Tax Asset a [(P100,000 + P120,000) + (P125,000 + P75,000)] – (P100,000 + P250,000) 70,000 a 49,000 21,000 Requirement (2) GOODY CONSTRUCTION COMPANY Condensed Comparative Income Statements (Partial) Income before income taxes Income taxes at 30% 2007 P400,000 (120,000) 2006 P200,000 (60,000) 2005 P220,000 (66,000) 19-20 Solutions Manual to Accompany Applied Auditing, 2006 Edition Net income Earnings per ordinary share (100,000 shares) P280,000 P140,000 P154,000 P2.80 P1.40 P1.54 Comparative Statements of Retained Earnings 2007 Balance at beginning of year, as previously reported Add: Adjustment for the cumulative effect on prior years of applying retroactively applying the new method of accounting for long-term contracts (net of income taxes) Balance at beginning of year, as adjusted Net income Balance at end of year 2006 2005 P245,000 c P 70,000 b 49,000 e 84,000 d P294,000 280,000 P574,000 P154,000 140,000 P294,000 P 0 P 154,000 P154,000 b P100,000 x (1 – 0.30) c P250,000 x (1 – 0.30) + P70,000 d [(P100,000 + P120,000) – P100,000] x (1 – 0.30) e [(P100,000 + P120,000 + P125,000 + P75,000) – (P100,000 + P250,000)] x (1 – 0.30) Note: The company has accounted for revenue and costs for long-term construction contracts by the percentage-of-completion method in 2007, whereas in prior years revenues and costs were determined by the competed-contract method The new method of accounting for long-term contracts was adopted to (state justification for change in accounting principle) and financial statements of prior years have been restated to apply the new method retroactively The effect of the accounting change on income of 2007 and on income as previously reported in 2005 and 2006 is as follows: 2007 Increase 2006 2005 Comprehensive Audit of Balance Sheet and Income Statement Accounts Net income Earnings per ordinary share P(49,000) P(0.49) h P(35,000) P(0.35) g 19-21 P84,000 P0.84 f The balances of retained earnings and deferred taxes for 2006 and 2007 have been adjusted for the after-tax effect of applying the new method of accounting retroactively: f (P220,000 – P100,000) x (1 – 0.30) g (P200,000 – P250,000) x (1 – 0.30) h [P400,000 – (P820,000 – P350,000)] x (1 – 0.30) Items Restated: On the 2005 and 2006 income statements, construction revenues and expenses would be restated to the appropriate amounts for the percentage of completion method The construction in progress, deferred income taxes, and retained earnings on the balance sheets would also be restated 19-10 Sand Company Requirement (1) a Incorrect entries: Building Notes Payable Depreciation Expense: Building (P60,000  30) Accumulated Depreciation: Building Correct entries: Building Discount on Notes Payable Notes Payable a 60,000 60,000 2,000 2,000 40,981 19,019 a 60,000 P60,000 x 0.683013 Depreciation Expense: Building Interest Expense Accumulated Depreciation Discount on Notes Payable b P40,981  30 c Interest computed using effective interest method: 10% x P40,981 Entries to correct error: Discount on Notes Payable 1,366 4,098 b c 1,366 4,098 19,019 19-22 Solutions Manual to Accompany Applied Auditing, 2006 Edition Building Accumulated Depreciation: Building Interest Expense Depreciation Expense: Building Discount on Notes Payable b c 19,019 634 4,098 634 4,098 Retained Earnings Cost of Goods Sold To correct error from prior year 40,000 Cost of Goods Sold Inventory To correct error in current year 15,000 40,000 15,000 The error from 2005 was counterbalanced at the end of 2006, so it can be ignored Retained earnings Salaries and Wages Expense To correct error in salary and wage accrual in 2006 18,000 Salaries and Wages Expense Salaries and Wages Payable To accrue salaries and wages at December 31, 2007 10,000 18,000 10,000 Requirement (2) a See Requirement 1.a of this solution for the incorrect entries that were made and the correct entries that should have been made Discount on Notes Payable (total discount of P19,019 less amount of P4,098 amortized for 2007) Accumulated Depreciation: Building Retained Earnings Building d b Correction of interest expense understatement of P4,098 less depreciation overstatement of P634 The error from 2006 was counterbalanced by the end of 2005, so it can be ignored 14,921 634 3,464 d 19,019 Comprehensive Audit of Balance Sheet and Income Statement Accounts Retained Earnings Inventory c 15,000 15,000 The errors from 2005 and 2006 were counterbalanced by the end of 2006 and 2007; respectively, so they can be ignored Retained Earnings Salaries and Wages Payable 19-11 19-23 10,000 10,000 Play Company Requirement (1) SFAS No 13 paragraphs 42 and 43 state that “a change in accounting policy should be applied retroactively unless the amount of any resulting adjustment that relates to prior periods is not reasonably determinable Any resulting adjustment should be reported as an adjustment to the opening balance of retained earnings Comparative information should be restated unless it is impracticable to so The financial statements, including the comparative information for prior periods, are presented as if the new accounting policy had always been in use Therefore, comparative information is restated in order to reflect the new accounting policy The amount of the adjusting relating to periods prior to those included in the financial statements is adjusted against the opening balance of retained earnings of the earliest period presented Any other information with respect to prior periods, such as historical summaries of financial data, is also restated.” PLAY COMPANY Worksheet to Correct Income Before Income Taxes Income before income taxes, before adjustments Adjustments: Depreciate certain equipment over 8-year life instead of 10-year life (Schedule 1) Correct 2006 error Record 2007 provision for doubtful accounts (P58,500,000 x 0.2%) Increase estimated warranty liability Effect of change in accounting principle from expensing to capitalizing relining costs in the year of the change (Schedule 2) Furnace A (Jan 2006) Year Ended December 31 2007 2006 P4,030,000 P3,330,000 (25,000) 180,000 (117,000) (170,000) (56,000) -(180,000) - 224,000 19-24 Solutions Manual to Accompany Applied Auditing, 2006 Edition Furnace B (Jan 2007) Net adjustments Income before income taxes 240,000 52,000 P4,082,000 -44,000 P3,374,000 Schedule 1: Computation of Adjusted Depreciation Cost of equipment (no salvage value) P1,000,000 Depreciation based on 10-year life Depreciation based on 8-year life Adjustment Schedule 2: Computation of Effect of Change in Accounting Principle From Expensing to Capitalizing Relining Costs on the Year of the Change Capitalization of Furnace B Depreciation on Furnace B based on 5-year life (P300,000 x 20%) Depreciation on Furnace A based on 5-year life (P280,000 x 20%) Adjustment P 100,000 (125,000) P (25,000) P300,000 (60,000) (56,000) P184,000 Requirement (2) PLAY COMPANY Effect Before Income Taxes of Change in Accounting Principle From Expensing to Capitalizing Relining Costs For Year Ended December 31, 2007 Capitalization of Furnace A Depreciation on Furnace A based on 5-year life (P280,000 x 20%) Adjustment 19-12 P280,000 (56,000) P224,000 Jo Francisco, Inc Item Net Income for 2005 Understated Overstated P14,100 P 7,000 0 P22,000 P33,000 0 P20,000 P18,200 Retained Earnings 12/31/06 Understated Overstated 0 P 5,000 0 P11,000 P33,000 0 P10,000 0 Comprehensive Audit of Balance Sheet and Income Statement Accounts 19-25 Although explanations were not required in answering the question, they are included below for your interest Explanations: 19-13 The net income would be understated in 2005 because interest income is understated The net income would be overstated in 2006 because interest income is overstated The errors, however, would counterbalance (wash) so that the Balance Sheet (Retained Earnings) would be correct at the end of 2006 The depreciation expense in 2005 should be P1,000 for this machine Since the machine was bought on July 1, 2005, only one-half of a year should be taken in 2005 (P8,000/4 X 1/2 = P1,000) The company expensed P8,000 instead of P1,000 so net income is understated by P7,000 in 2006 An additional P2,000 of depreciation expense should have been taken in 2006 At the end of 2006, retained earnings would be understated by P5,000 (P7,000 – P2,000) PAS 38, paragraphs 54 to 57 govern the accounting for research and development costs Net income in 2005 is overstated P22,000 (P33,000 research and development costs capitalized less P11,000 amortized) By the end of 2006, only P11,000 of the research and development costs would remain as an asset Therefore, retained earnings would be overstated by P11,000 (P33,000 research and development costs – P22,000 amortized) The security deposit should be a long-term asset, called refundable deposits The P8,000 of last month’s rent is also an asset, called prepaid rent The net income of 2005 is understated by P33,000 (P25,000 + P8,000) because these amounts were expensed Retained earnings will continue to be understated by P33,000 until the last year of the lease The security deposit will then be refunded, and the last month’s rent should be expensed P10,000 or one-third of P30,000 should be reported as income each year In 2005, P30,000 was reported as income when only P10,000 should have been reported Because P20,000 too much was reported, the net income of 2005 is overstated At the end of 2006, P20,000 should have been reported as income, so retained earnings is still overstated by P10,000 (P30,000 – P20,000) The ending inventory would be understated since the merchandise was omitted Because ending inventory and net income have a direct relationship, net income in 2005 would be understated The ending inventory of 2005 becomes the beginning inventory of 2006 If beginning inventory of 2006 is understated, then net income of 2006 is overstated (inverse relationship) The omission in inventory over the two-year period will counterbalance, and retained earnings at the end of 2006 will be correct JC Patrick Corporation 19-26 Solutions Manual to Accompany Applied Auditing, 2006 Edition Net income, as reported Rent received in 2006, earned in 2007 Wages not accrued, 12/31/05 Wages not accrued, 12/31/06 Wages not accrued, 12/31/07 Inventory of supplies, 12/31/05 Inventory of supplies, 12/31/06 Inventory of supplies, 12/31/07 Corrected net income 2006 P29,000 (1,300) 1,100 (1,500) (1,300) 740 P26,740 2007 P37,000 1,300 1,500 (940) (740) 1,420 P39,540 ...19-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition (5) (6) (7) (8) (9) Administrative expenses Allowance... P1,182,000 P1,007,300 174,700 P1,051,500 P1,051,500 P1,182,000 P1,182,000 19-4 Solutions Manual to Accompany Applied Auditing, 2002 Edition 19-2 Part I Adjusting Journal Entries, 12-31-05 AJE (1)... delivery vehicle Cost of sales Retained earnings 3,200 3,200 19,000 19,000 19-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition (3) (4) (5) (6) (7) (8) (9) Cost of sales Inventory 8,500