Solution manual applied auditing by cabrera chapter19 answer

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]
9
(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
0

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
6

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 1
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 1
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


Comprehensive Audit of Balance Sheet and Income Statement Accounts
Supplies inventory.................................................
Investments:
Cash surrender value of life insurance...................
Land, buildings and equipment:
Land......................................................................
Buildings................................................ P62,000
Less accumulated depreciation.......... 7,750
Fixtures................................................... P12,500
Less accumulated depreciation.......... 2,100
Delivery truck.......................................................
Total assets.................................................................
Liabilities
Current liabilities:
Mortgage payable, portion due this year................
Accounts payable..................................................

Interest payable.....................................................
Miscellaneous accrued liabilities...........................
11% Mortgage payable (noncurrent portion)...............
Total liabilities............................................................
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
Retained earnings.......................................................
Total owners’ equity....................................................
Total liabilities and owners’ equity..............................
19-6.

425

19-11
P 34,140

4,100
P30,000
54,250
10,400
2,100

P 4,000
29,000
880

3,950

96,750
P134,990

P 37,830
12,000
P 49,830

P55,000
30,160
85,160
P134,990

Masipag Corporation
Adjusting Journal Entries, Dec. 31, 2007
AJE (1)
(2)

Cash
Accounts payable
Accounts receivable
Cash

200,000
200,000
10,000
10,000

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
0
3,187,50
0

Land and building
(30) Building
Land and building

19-13

4,250,00
0
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

0
P

0

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. 1

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

0
P
0
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 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

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
1.
2.
3.
4.
5.
6.

Net Income for 2005
Understated
Overstated
P14,100
0
P 7,000
0
0
P22,000
P33,000
0
0
P20,000
P18,200
0

Retained Earnings 12/31/06

Understated
Overstated
0
0
P 5,000
0
0
P11,000
P33,000
0
0
P10,000
0
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.

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.

JC Patrick Corporation