chapter . solutions manual to accompany applied auditing, 2002 edition. 19-2. part i. adjusting...

19

CHAPTER COMPREHENSIVE AUDIT OF

BALANCE SHEET AND INCOME STATEMENT ACCOUNTS

19-1. Daffodil, Inc. Adjusting Journal Entries 12.31.07

AJE (1) Share donation 60,000 Treasury shares 35,000 Land 10,000 Building 15,000

(2) Accumulated depreciation - machinery 1,000 Loss on sale of machinery 2,000 Machinery 3,000 Cost P 5,000 Less: AD (20%) 1,000 NBV P 4,000 Proceeds 2,000 Loss P 2,000

(3) (a) Accumulated depreciation - building 300 Retained earnings 300 (b) Factory operating expenses 21,300 Accumulated depreciation - building 6,300 Accumulated depreciation - machinery 15,000 Building (P315,000 x 2%) Machinery: 5,000 x 10% = P 500 145,000 x 10% = 14,500 P15,000

(4) Merchandise inventory, 12.31.07 B/S 175,000 Merchandise inventory, 12.31.07 I/S 175,000

19-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition

(5) Administrative expenses 1,000 Allowance for doubtful accounts 1,000

(6) Factory operating expenses 3,000 Unexpired insurance 3,000

(7) Retained earnings 2,500 Bond interest expense 2,500 Unamortized bond discount 5,000

(8) Sinking fund assets 23,500 First Mortgage SF Bonds 23,500

(9) Sinking fund assets 1,500 Sinking fund income 1,500

Comprehensive Audit of Balance Sheet and Income Statement Accounts 19-3 19-1. Daffodil, Inc. (continued)

Daffodil, Inc. Working Trial Balance

12.31.07

Trial Balance Adjustments Income Statement Balance Sheet Dr Cr Dr Cr Dr Cr Dr Cr

Cash P 64,000 P 64,000 Accounts receivable 200,000 200,000 Provision for doubtful accounts P 1,000 (5) 1,000 P 2,000 Inventories, 12.31.06 223,000 P 223,000 Unexpired insurance, 12.31.06 6,000 (6) 3,000 3,000 Land 220,000 (1) 10,000 210,000 Buildings 330,000 (1) 15,000 315,000 Accumulated Depreciation - Buildings 6,600 (3a) 300 (3b) 6,300 12,600 Machinery 148,000 (2) 3,000 145,000 Accumulated Depreciation - Machinery 15,000 (2) 1,000 (3b) 15,000 29,000 Sinking fund assets 25,000 (8) 23,500 (9) 1,500 50,000 Unamortized bond discount 25,000 (7) 5,000 20,000 Treasury shares, ordinary 35,000 (1) 35,000 - Accounts payable 88,000 88,000 Bond interest accrued 3,750 3,750 1st Mortgage, 6% SF Bonds 226,500 (8) 23,500 250,000 Ordinary shares 500,000 500,000 Premium on ordinary shares 50,000 50,000 Share donation 60,000 (1) 60,000 - Retained earnings, 12.31.06 74,150 (7) 2,500 (3a) 300 71,950 Sales 875,000 P 875,000 Purchases 283,500 283,500 Payroll 169,000 169,000 Factory operating expenses 121,500 (3b) 21,300 (6) 3,000 145,800 Administrative expenses 35,000 (5) 1,000 36,000 Bond interest expense 15,000 (7) 2,500 17,500 P1,900,000 P1,900,000 Loss on sale of machinery (2) 2,000 2,000 Merchandise inventory 12.31.07 (4) 175,000 (4) 175,000 175,000 175,000 Sinking fund income (9) 1,500 1,500

P 293,600 P 293,600 P 876,800 P1,051,500 P1,182,000 P1,007,300 Net Income 174,700 174,700

P1,051,500 P1,051,500 P1,182,000 P1,182,000


19-2. Part I Adjusting Journal Entries, 12-31-05

AJE (1) Depreciation expense 1,778 Accumulated depreciation 1,778

(2) Prepaid interest 5,000 Retained earnings 3,100 Interest expense 1,900

(3) Merchandise inventory, 12-31-07, BS 15,000 Merchandise inventory, 12-31-07, IS or

Cost of Sales 15,000

(4) Retained Earnings 6,000

Purchases 6,000

(5) Prepaid insurance 3,000 Insurance expense 3,000

(6) Store supplies inventory 1,450 Store supplies expense 550 Retained earnings 900

(7) Retained earnings 730 Commissions expense 240 Accrued commissions payable 970

(8) Cash in bank 650 Miscellaneous income 650

(9) Purchases 800 Accounts payable 800

(10) Income from Investment 3,000 Investment 3,000

(11) Prepaid advertising and promotions 90,000 Advertising and promotions expense 90,000

(12) NO AJE

(13) Machinery 20,000 Depreciation expense – machinery 167 Allowance for depreciation – machinery 167 Repairs and maintenance 20,000

[(P22,000 – P2,000) – P4,000] 9

Comprehensive Audit of Balance Sheet and Income Statement Accounts 19-5

(14) Miscellaneous income 2,000 Gain on sale of treasury shares 5,000 Land 2,000 Additional paid-in capital arising from

Treasury Share transactions

5,000

(15) Doubtful accounts expense 14,500 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

P 1,500 4,000 P 5,500

9,000 P14,500

Part II Column B – Adjustment, 12-31-07

AJE (a) Retained earnings xx Purchases xx

(b) NONE xx xx

(c) Retained Earnings xx Allowance for depreciation xx

(d) Retained Earnings xx Allowance for depreciation xx

(e) Machinery xx Retained earnings xx

(f) Depreciation xx Allowance for depreciation xx

(g) Retained earnings xx Taxes xx

19-3. International Company

AJE (1) Depreciation expense 3,200 Accumulated depreciation – delivery vehicle 3,200

(2) Cost of sales 19,000 Retained earnings 19,000


(3) Cost of sales 8,500 Inventory 8,500

(4) Cash 5,600 Accounts receivable 5,600

(5) Accumulated depreciation – equipment 22,000 Equipment 18,300 Gain on sale of equipment 3,700

(6) Estimated litigation loss 125,000 Estimated litigation liability 125,000

(7) Unrealized holding gain or loss – Income 2,000 Allowance for decline in value of securities 2,000

(8) Accrued salaries payable 3,800 Salaries expense 3,800

(9) Depreciation expense 4,000 Equipment 32,000 Repairs expense 32,000 Accumulated depreciation – equipment 4,000

(10) Insurance expense 5,000 Prepaid insurance 7,000 Retained earnings 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) Inventory, Dec. 31, 2006 (BS) 67,200 Inventory, Dec. 31, 2006 (IS) or

Cost of sales

67,200

(2) Doubtful accounts expense 14,920 Allowance for doubtful accounts

(15,660 – 740)

14,920

(3) Accounts payable 20,760 Purchase returns and allowances 20,760


(4) Sales commissions 216 Accrued commissions payable 216

(5) Freight-in 1,600 Accounts payable 1,600

(6) Advertising expense 1,212 Prepaid advertising 1,212

(7) Freight-out or Expense 8,400 Sales 8,400

(8) Interest receivable 1,380 Interest income 1,380

(9) Depreciation expense 1,300 Accumulated depreciation 1,300

(10) Supplies expense 1,160 Unused Supplies 1,160

(11) Provision for Income tax expense 107,386 Income tax payable 107,386

Requirement (2) Sunshine Cosmetics, Inc.

Income Statement For the Year Ended December 31, 2006

Revenue from sales: Sales P998,800 (a) Less: Sales returns and and allowances

P 22,400

Sales discounts 1,760 24,160 P974,640 Cost of goods sold: Inventory, January 1 P179,400 Net purchases: Purchases P346,000 Less purchase returns and allowances

20,760 (c)

325,240

Freight-in 12,650 (b) Cost of goods available for sale

P517,290

Less Inventory, December 31 108,300 (d) 408,990 Gross profit on sales P565,650


Other income: Interest revenue P 2,780 (i) Dividend revenue 14,300 Gain on sale of assets 37,000 54,080 Total income P619,730 Operating expenses: Selling expenses: Sales salaries and commissions

P 70,216 (e)

Advertising expense 33,392 (f) Depreciation expense – Sales/delivery equipment

13,500 (g)

Freight expense 8,400 Travel expense – sales representatives

9,120

Miscellaneous selling expenses

4,400

P139,028

General and administrative expenses:

Legal services P 4,450 Insurance and licenses 17,000 Depreciation expense – office equipment

9,600

Utilities 12,800 Telephone and postage 2,950 Supplies expense 1,160 (k) Officers’ salaries 73,200 Doubtful accounts expense 14,920 (h) 136,080 Total operating expenses (275,108) Other expense and losses: Interest expense P 9,040 Loss on sale of equipment 45,200 (54,240) Income from continuing operations before income taxes

P290,382

Income taxes 92,922 (j) Income from continuing operations

P197,460

Discontinued operations: Gain from discontinued operations (net of income taxes of P25,600)

54,400

Net income P251,860


Earnings per ordinary share: Income from continuing operations (P197,460 ÷ 78,000 shares) P2.53 Gain from discontinued operations (P54,400 ÷ 78,000 shares) 0.70 Net income (P251,860 ÷ 78,000 shares) P3.23

Computations: (a) Sales: P990,400 + P8,400 = P998,800 (b) Freight-in: P11,050 + P1,600 = P12,650 (c) Purchase returns and allowances: P346,000 x 6% = P20,760 (d) Inventory: P41,100 + P67,200 = P108,300 (e) Sales salaries and commissions: P70,000 + (P7,200 x 3%) = P70,216 (f) Advertising expense: P32,180 + (P3,636 x 2/6) = P33,392 (g) Depreciation expense: P12,200 + (P15,600 x 10/120) = P13,500 (h) Doubtful accounts expense: (P522,000 x 3%) – P740 = P14,920 (i) Interest revenue: P1,400 + P1,380 = P2,780 (j) Income taxes: P335,582 x 32% = P107,387 (k) Supplies expense: P4,360 – P3,200 = P1,160

Sunshine Cosmetics, Inc.

Retained Earnings Statement For the Year Ended December 31, 2006

Retained earnings, January 1 P 881,340 Add net income per income statement 251,860 P1,133,200 Deduct dividends paid 66,000 Retained earnings, December 31 P1,067,200

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

Balance Sheet Corrections Corrected Balance Sheet Account Title Debit Credit Debit Credit Debit Credit

Current Assets ..................... 53,415 .............. .............. (a) 53,415 ............. .............. Current Liabilities ................. ............. 29,000 (c) 29,000 ............. ............. .............. Other Assets ........................ 75,120 .............. .............. (b) 75,120 ............. .............. Other Liabilities .................... ............. 3,600 (d) 3,600 ............. ............. .............. Investment in Business ........ ............. 95,935 (e) 95,935 ............. ............. .............. 128,535 128,535 .............. ............. ............. ..............


Cash ..................................... ............. .............. (a) 10,600 ............. 10,600 .............. Investment Securities – trading (at market value) ....

.............

..............

(a) 2,575

.............

2,575

..............

Trade Accounts Receivable . ............. .............. (a) 12,500 ............. 12,500 .............. Inventory............................... ............. .............. (a) 8,040 ............. 8,040 .............. Supplies Inventory................ ............. .............. (a) 425 ............. 425 .............. Delivery Truck ...................... ............. .............. (a) 2,100 ............. 2,100 .............. Fixtures................................. ............. .............. (a) 12,500 ............. 12,500 .............. Accumulated Depreciation – Fixtures...............................

.............

..............

..............

(a) 2,100

.............

2,100

Cash Surrender Value of Insurance on Officers’

Lives ...................................

.............

..............

(a) 4,100

.............

4,100

..............

Retained Earnings................ ............. .............. (a) 2,675 ............. ............. .............. ............. .............. (b) 7,750 ............. ............. .............. ............. .............. (d) 350 ............. ............. 30,160 ............. .............. .............. (e) 40,935 ............. .............. Land ..................................... ............. .............. (b) 30,000 ............. 30,000 .............. Buildings............................... ............. .............. (b) 62,000 ............. 62,000 .............. Accumulated Depreciation – Buildings [2 ½ (P62,000 ÷ 20)]

.............

..............

..............

(b) 7,750

.............

7,750 11% Mortgage Payable........ ............. .............. .............. (b) 12,000 ............. 12,000 11% Mortgage Payable (current portion)..................

.............

..............

..............

(b) 4,000

.............

4,000

Interest Payable ................... ............. .............. .............. (b) 880 ............. 880 Trade Accounts Payable...... ............. .............. .............. (c) 29,000 ............. 29,000 Miscellaneous Liabilities ...... ............. .............. .............. (d) 3,950 ............. 3,950 Share Capital, P5 stated value, 5,000 shares............

.............

..............

..............

(e) 25,000

.............

25,000

Paid-in Capital from Sale of Shares at More Than Stated Value.......................

.............

..............

..............

(e) 30,000

.............

30,000 284,150 284,150 144,840 144,840

Corrections: (a) To restate current assets (d) To restate other liabilities (b) To restate other assets (e) To restate owners’ equity accounts (c) To restate current liabilities

Del Bakery Corrected Balance Sheet

December 31, 2007

Assets Current assets: Cash ........................................................................ P10,600 Investment securities – trading (reported at market; cost P4,250) .........................................

2,575

Trade accounts receivable (fully collectible).......... 12,500 Inventory................................................................. 8,040 Supplies inventory .................................................. 425 P 34,140


Investments: Cash surrender value of life insurance.................... 4,100 Land, buildings and equipment: Land........................................................................ P30,000 Buildings.................................................. P62,000 Less accumulated depreciation .......... 7,750 54,250 Fixtures .................................................... P12,500 Less accumulated depreciation .......... 2,100 10,400 Delivery truck......................................................... 2,100 96,750 Total assets ................................................................... P134,990

Liabilities Current liabilities: Mortgage payable, portion due this year ................ P 4,000 Accounts payable.................................................... 29,000 Interest payable....................................................... 880 Miscellaneous accrued liabilities ............................ 3,950 P 37,830 11% Mortgage payable (noncurrent portion) ............... 12,000 Total liabilities.............................................................. P 49,830

Owners’ Equity Contributed capital: Share capital, P5 stated value, 5,000 shares ....................................... P25,000

Paid-in capital from sale of ordinary shares at more than stated value ........................................ 30,000

P55,000

Retained earnings ......................................................... 30,160 Total owners’ equity..................................................... 85,160 Total liabilities and owners’ equity .............................. P134,990

19-6. Masipag Corporation Adjusting Journal Entries, Dec. 31, 2007

AJE (1) Cash 200,000 Accounts payable 200,000

(2) Accounts receivable 10,000 Cash 10,000

(3) Bank loan payable 400,000 Other expenses 12,500 Cash 412,500


(4) Cash 75,000 Accounts receivable 75,000

(5) Operating expenses 1,500 Cash 1,500

(6) Cash 16,000 Other income 16,000

(7) Accounts receivable – others (2,000 + 3,000) 5,000 Operating expenses 2,000 Cash 7,000

(8) Marketable securities 40,000 Other income 40,000

(9) Other income 54,000 Marketable securities 54,000

(10) Marketable securities 32,000 Other income 32,000

(10.a) Valuation allowance – Marketable securities – Trading

145,600

Other income – Unrealized holding gain 145,600

(11) Sales 500,000 Accounts receivable 500,000

(12) Inventory 400,000 Cost of sales 400,000

(13) Accounts receivable – others (30,000 – 15,000) 15,000 Accounts receivable 15,000

(14) Accounts receivable – others 55,000 Accounts receivable 55,000

(15) Accounts receivable 50,000 Other current liabilities 50,000

(16) Operating expenses 21,900 Allowance for doubtful accounts 21,900

(17) Other income 54,545 Discount on notes receivable 54,545

(18) Discount on notes receivable 4,545 Other income 4,545


(19) Cost of sales 60,000 Accounts payable 60,000

(20) Cost of sales 25,000 Accounts payable 25,000


(22) Accounts receivable – others 16,000 Inventory 16,000


(24) Operating expenses 46,250 Prepaid expenses 46,250

(25) Operating expenses 5,000 Prepaid expenses 5,000

(26) Other assets 60,000 Operating expense 120,000 Prepaid expenses 180,000

(27) Long-term bond investment 5,777 Other income 5,777

(28) Accounts receivable – others 5,333 Other income 5,333

(29) Land 1,062,500 Building 3,187,500 Land and building 4,250,000

(30) Building 425,000 Land and building 425,000

(31) Operating expenses 20,000 Land and building 20,000

(32) Operating expenses 27,500 Prepaid expenses 27,500 Land and building 55,000


(33) Land and building 237,500 Operating expenses 115,578 Accumulated depreciation – building 121,922

(34) Prepaid expenses 10,000 Operating expenses 10,000 Equipment 20,000

(35) Operating expenses 55,400 Accumulated depreciation – equipment 55,400

(36) Accounts payable 50,000 Other current liabilities 50,000

(37) Operating expenses 15,000 Estimated liability on warranties 15,000

(38) Other current liabilities 50,000 Other expenses 50,000

(39) Income taxes payable 115,290 Provision for income tax 115,290

MASIPAG CORPORATION

Balance Sheet December 31, 2007

Assets

Current assets Cash P 734,000 Marketable securities P 400,000 Valuation allowance 145,600 545,600 Accounts receivable P 442,000 Allowance for doubtful accounts (33,150) 408,850 Notes receivable P 600,000 Discount on notes receivable (50,000) 550,000 Accounts receivable – others 96,333 Inventory, December 31, 2007 1,960,500 Prepaid expenses 175,250 Total current assets P4,470,533 Investments Long-term bond investment 744,077 Property, plant and equipment Land P1,062,500 Building P3,612,500 Accumulated depreciation – Building (121,922) 3,490,578


Equipment P1,654,000

Accumulated depreciation – Equipment (235,400) 1,418,600

Total property, plant and equipment

5,971,678 Other assets 110,000 Total assets P11,296,288

Liabilities and Shareholders’ Equity Current liabilities Accounts payable P 877,000 Bank loan payable 1,100,000 Accrued expenses payable 59,000 Other current liabilities 100,000 Income taxes payable 130,558 Estimated liability on warranties 70,000 Total current liabilities P 2,336,558 Shareholders’ equity Ordinary shares P5,000,000 Additional paid-in capital 1,655,250 Retained Earnings 2,304,480 Total shareholders’ equity 8,959,730 Total liabilities and shareholders’ equity P11,296,288

MASIPAG CORPORATION


Sales P 6,437,000 Cost of sales (4,060,000)Gross profit P 2,377,000 Other income 225,710 Operating expenses (1,511,509)Other expenses (37,500)Income before taxes P 1,053,701Provision for income tax (342,441)Net Income P 711,260

19-7. Felicity Company Adjusting Journal Entries, Dec. 31, 2007

AJE (1) Cash 31,000 Prepaid interest 3,000 Other charges 2,000 Long-term debt (current portion) 24,000 Long-term debt 12,000


(2) Cash 2,000 Accounts payable and others 2,000

(3) Investments in SMC shares – available for sale (non-current)

72,000

Marketable securities 72,000

(4) Unrealized loss due to decline in value of non-current investment (equity)

20,000

Operating expenses 20,000

(5) Allowance for doubtful accounts 41,100 Operating expenses 41,100

(6) Accounts receivable 8,000 Operating expenses 8,000



(9) Revaluation increment 120,000

Accumulated depreciation 80,000 Property and equipment 200,000

(10) Accumulated depreciation 36,000 Operating expenses 36,000

(11) Operating expenses 48,000 Accumulated depreciation 48,000

(12) Revaluation increment 24,000 Retained earnings 24,000

(13) Property and equipment 30,000 Operating expenses 30,000

(14) Retained earnings 13,000 Cumulative effect of change in accounting

principle 13,000

(15) Accounts receivable – others 22,000

Cash 22,000


(16) Provision for income tax 25,445 Income tax payable 25,445

FELICITY COMPANY Balance Sheet

December 31, 2007

Assets

Current Assets: Cash............................................................................................ P 123,600 Accounts receivable ................................................................... 1,751,820 Allowance for doubtful accounts ............................................... (27,000) Accounts receivable -others ....................................................... 62,000 Inventories.................................................................................. 262,000 Prepaid interest........................................................................... 3,000

Non-current Assets: Advances to affiliate .................................................................. 48,000 Investments in SMC shares – available for sale ......................... 72,000 Allowance for decline in value of non-current investment ........ (20,000) Property and equipment ............................................................. 2,600,000 Accumulated depreciation.......................................................... (1,172,000) Total Assets P 3,703,420

Liabilities and Shareholders’ Equity

Accounts payable and others (including current portion of bank loan of P24,000) ............................................................... P 434,616 Income tax payable............................................................................ 100,205 Long-term debt.................................................................................. 72,000 Ordinary share capital ....................................................................... 2,042,000 Retained earnings .............................................................................. 978,599 Unrealized loss due to decline in value of investment in SMC ......... (20,000) Revaluation increment....................................................................... 96,000 Total Liabilities and Shareholders’ Equity P 3,703,420

FELICITY COMPANY


Sales .................................................................................................. P 2,757,124 Cost of sales ...................................................................................... 2,257,604 Gross profit........................................................................................ P 499,520 Operating expenses ........................................................................... (83,522) Other charges..................................................................................... (102,000)


Income from continuing operations before tax.................................. P 313,998 Provision for income tax (35%) ........................................................ 109,899 Income from continuing operations after tax .................................... P 204,099 Discontinued operations (net) ........................................................... (6,500) Net income ........................................................................................ P 197,599 19-8. Learn Company

Condensed Comparative Income Statements

2009 2008 2007 Construction revenue P900,000 P420,000 P200,000 Construction expense (420,000) (182,000) (80,000) Other expenses (80,000) (70,000) (50,000) Income before income taxes P400,000 P168,000 P 70,000 Income tax expense (120,000) (50,400) (21,000) Net income P280,000 P117,600 P 49,000

Comparative Statements of Retained Earnings

2009 2008 2007

Balance at beginning of year, as previously reported

P 77,000

P 7,000

P 0

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)

89,600 b

42,000 a

0

Balance at beginning of year, as adjusted

P166,600

P 49,000

P 0

Net income 280,000 117,600 49,000 Balance at end of year 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:

Increase 2009 2008 2007

Net income P112,000 c P47,600 P42,000 Earnings per ordinary share P11.20 P4.76 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 P280,000 – [(P600,000 – P280,000 – P80,000) x (1 – 0.30)] 19-9. Goody Construction Company Requirement (1)

2007 Jan. 1 Construction in Progress 70,000 a

Retained Earnings [P70,000 x (1 – 0.30)] 49,000 Deferred Tax Asset 21,000 a [(P100,000 + P120,000) + (P125,000 +

P75,000)] – (P100,000 + P250,000)

Requirement (2)

GOODY CONSTRUCTION COMPANY Condensed Comparative Income Statements (Partial)

2007 2006 2005

Income before income taxes P400,000 P200,000 P220,000 Income taxes at 30% (120,000) (60,000) (66,000) Net income P280,000 P140,000 P154,000 Earnings per ordinary share (100,000 shares)

P2.80

P1.40

P1.54


Comparative Statements of Retained Earnings

2007 2006 2005 Balance at beginning of year, as previously reported

P245,000 c

P 70,000 b

P 0

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)

49,000 e

84,000 d

0

Balance at beginning of year, as adjusted

P294,000

P154,000

P 0

Net income 280,000 140,000 154,000 Balance at end of year P574,000 P294,000 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:

Increase 2007 2006 2005

Net income P(49,000) h P(35,000) g P84,000 f Earnings per ordinary share P(0.49) P(0.35) P0.84

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 60,000 Notes Payable 60,000

Depreciation Expense: Building (P60,000 ÷ 30)

2,000

Accumulated Depreciation: Building 2,000 Correct entries: Building 40,981 a Discount on Notes Payable 19,019 Notes Payable 60,000

a P60,000 x 0.683013

Depreciation Expense: Building 1,366 b Interest Expense 4,098 c Accumulated Depreciation 1,366 Discount on Notes Payable 4,098

b P40,981 ÷ 30 c Interest computed using effective interest method: 10% x P40,981

Entries to correct error: Discount on Notes Payable 19,019 Building 19,019

Accumulated Depreciation: Building 634 Interest Expense 4,098 Depreciation Expense: Building 634 Discount on Notes Payable 4,098 b. Retained Earnings 40,000 Cost of Goods Sold 40,000 To correct error from prior year.


Cost of Goods Sold 15,000 Inventory 15,000 To correct error in current year. c. The error from 2005 was counterbalanced at

the end of 2006, so it can be ignored.

Retained earnings 18,000 Salaries and Wages Expense 18,000

To correct error in salary and wage accrual in 2006.

Salaries and Wages Expense 10,000 Salaries and Wages Payable 10,000

To accrue salaries and wages at December 31, 2007.

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)

14,921

Accumulated Depreciation: Building 634 Retained Earnings 3,464 d Building 19,019 d Correction of interest expense understatement of P4,098 less depreciation overstatement of P634

b. The error from 2006 was counterbalanced

by the end of 2005, so it can be ignored.

Retained Earnings 15,000 Inventory 15,000 c. The errors from 2005 and 2006 were counterbalanced by the end of 2006 and

2007; respectively, so they can be ignored. Retained Earnings 10,000 Salaries and Wages Payable 10,000


19-11. 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 do 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

Year Ended December 31 2007 2006 Income before income taxes, before adjustments P4,030,000 P3,330,000 Adjustments: Depreciate certain equipment over 8-year life instead of 10-year life (Schedule 1)

(25,000)

--

Correct 2006 error 180,000 (180,000)Record 2007 provision for doubtful accounts (P58,500,000 x 0.2%)

(117,000)

--

Increase estimated warranty liability (170,000) -- Effect of change in accounting principle from expensing to capitalizing relining costs in the year of the change (Schedule 2)

Furnace A (Jan. 2006) (56,000) 224,000 Furnace B (Jan. 2007) 240,000 -- Net adjustments 52,000 44,000 Income before income taxes P4,082,000 P3,374,000

Schedule 1:

Computation of Adjusted Depreciation

Cost of equipment (no salvage value) P1,000,000

Depreciation based on 10-year life P 100,000 Depreciation based on 8-year life (125,000) Adjustment P (25,000)


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 P300,000 Depreciation on Furnace B based on 5-year life (P300,000 x 20%)

(60,000)

Depreciation on Furnace A based on 5-year life (P280,000 x 20%)

(56,000)

Adjustment 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 P280,000 Depreciation on Furnace A based on 5-year life (P280,000 x 20%)

(56,000)

Adjustment P224,000

19-12. Jo Francisco, Inc.

Net Income for 2005 Retained Earnings 12/31/06 Item Understated Overstated Understated Overstated

1. P14,100 0 0 0 2. P 7,000 0 P 5,000 0 3. 0 P22,000 0 P11,000 4. P33,000 0 P33,000 0 5. 0 P20,000 0 P10,000 6. P18,200 0 0 0

Although explanations were not required in answering the question, they are included below for your interest.

Explanations:

1. 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.


2. 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).

3. 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).

4. 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.

5. 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).

6. 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.

19-13. JC Patrick Corporation

2006 2007 Net income, as reported P29,000 P37,000 Rent received in 2006, earned in 2007 (1,300) 1,300 Wages not accrued, 12/31/05 1,100 Wages not accrued, 12/31/06 (1,500) 1,500 Wages not accrued, 12/31/07 (940) Inventory of supplies, 12/31/05 (1,300) Inventory of supplies, 12/31/06 740 (740) Inventory of supplies, 12/31/07 1,420 Corrected net income P26,740 P39,540

chapter . solutions manual to accompany applied auditing, 2002 edition. 19-2. part i. adjusting...

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