EMILIO AGUINALDO COLLEGE – CAVITE

CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

HANDOUT 2
CORRECTION OF ERRORS

Problem 1
The first audit of the books of Luzon Company was made for the year ended December 31,
20x6. In examining the books, the auditor found that certain items had been overlooked or
incorrectly handled in the last 3 years. These items are:

a. At the beginning of 20x4, the company purchased a machine for P1,020,000 (salvage
value of P102,000) that had a useful life of 6 years. The bookkeeper used straight-line
depreciation, but failed to deduct the salvage value in computing the depreciation base
for the 3 years.

b. At the end of 20x5, the company failed to accrue sales salaries of P90,000.

c. A tax lawsuit that involved the year 20x4 was settled late in 20x6. It was determined
that the company owed an additional P170,000 in taxes related to 20x4. The company
did not record a liability in 20x4 or 20x5 because the possibility of loss was considered
remote, and charged the P170,000 to a loss account in 20x6.

d. Luzon Company purchased another company early in 20x4 and recorded goodwill of
P900,000. Luzon had not amortized goodwill because its value had not diminished. The
estimated economic life of the goodwill is 20 years.

e. In 20x6, the company wrote off P174,000 of inventory considered to be obsolete; this
loss was charged directly to Retained Earnings.

f. Year-end wages payable of P6,800 were not recorded because the bookkeeper thought
that “they were immaterial.”

g. Insurance for a 12-month period purchased on November 1 of this year was charged to
insurance expense in the amount of P5,280 because “the amount of the check is about
the same every year.

Questions

1. The entry to record the adjustment of item “a” is:

a. Accumulated depreciation 34,000
Retained earnings 17,000
Depreciation expense 17,000
b. Accumulated depreciation 51,000
Retained earnings 34,000
Depreciation expense 17,000
c. Accumulated depreciation 17,000
Depreciation expense 17,000
d. Accumulated depreciation 17,000
Retained earnings 17,000

2. The entry to record the adjustment of item “c”:

a. No adjustment.
b. Retained earnings 170,000
Estimated liability 170,000
c. Loss on damages 170,000
Estimated liability 170,000
d. Loss on damages 170,000
Cash 170,000
3. Net income of 20x5 is overstated by:
a. P 460,400 b. P 318,400 c. P 107,000 d. P 73,000

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

4. Net income of 20x6 is overstated by:

a. P 367,000 b. P 312,000 c. P 103,400 d. P 69,400

Solution
a. Accumulated depreciation 51,000
Depreciation expense (20x6) 17,000
Retained earnings (20x4 & 20x5) 34,000
b. Retained earnings 90,000
Salaries expense 90,000
c. No adjustment
d. No adjustment since no indication of impairment.
e. Loss on obsolete inventory 174,000
Retained earnings 174,000
f. Salaries expense 6,800
Salaries payable 6,800
g. Prepaid insurance 4,400
Insurance expense 4,400

20x4 20x5 20x6

Item A 17,000 17,000 17,000
Item B (90,000) 90,000
Item C - - -
Item D
Item E (174,000)
Item F (6,800)
Item G ___________ __________ 4,400
Net Effect 17,000 (73,000 (69,400)

Answer:
1. B 2. A 3. D 4. D
Problem 3
A partial trial balance of Josh Alejandro Corporation is as follows on December 31, 20x6:
Dr.____ ____Cr.____
Supplies on hand P 13,500
Accrued salaries and wages P 7,500
Interest receivable on investments 25,500
Prepaid insurance 450,000
Unearned rent -0-
Accrued interest payable 75,000

Additional adjusting data:

a. A physical count of supplies on hand on December 31, 20x6, totaled P5,500.

b. Through oversight, the Accrued Salaries and Wages account was not changed during
20x6. Accrued salaries and wages on 12/31/x6 amounted to P22,000.

c. The interest receivable on investments account was also left unchanged during 20x6.
Accrued interest on investments amounts to P21,750 on 12/31/x6.

d. The unexpired portions of the insurance policies totaled P325,000 as of December

31, 20x6.

e. P140,000 was received on January 1, 20x5, for the rent of a building for both 20x5
and 20x6. The entire amount was credited to rental income.

f. Depreciation for the year was erroneously recorded as P25,000 rather than the
correct figure of P250,000.

g. A further review of depreciation calculations of prior year revealed that depreciation

of P36,000 was not recorded. It was decided that this oversight should be corrected by a
prior period adjustment.

Questions

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

1. The accrued salaries and wages at year-end is:

a. P 29,500 b. P22,000 c. P 14,500 d. P 7,500

2. How much is the adjusted salaries and wages at year-end assuming that the balance of
this account in the book is P350,000?
a. P 379,500 b. P 372,000 c. P 364,500 d. P 342,500

3. Prepaid insurance at year-end is:

a. P 450,000 b. P 325,000 c. P 125,000 d. P 0
4. Supplies on hand at year-end is:
a. P 13,500 b. P 8,000 c. P 5,500 d. P 2,500

5. Depreciation expense at year-end is:

a. Understated by P225,000
b. Overstated by P225,000
c. Understated by P261,000
d. Overstated by P261,000

Solution
1. Supplies expense 8,000
Supplies on hand 8,000
2. Accrued salaries and wages 7,500
Salaries and wages expense 7,500
To reverse accrued salaries.
Salaries and wages expense 22,000
Accrued salaries and wages 22,000
3. Interest income 25,500
Interest receivable 25,500
To reverse accrued income.
Interest receivable 21,750
Interest income 21,750
4. Insurance expense 125,000
Prepaid insurance 125,000
5. Retained earnings 70,000
Rent income 70,000
6. Depreciation expense 225,000
Accumulated depreciation 225,000
7. Retained earnings 36,000
Accumulated depreciation 36,000
Answer:
1. B 2. C 3. B 4. C 5. A
Problem 5
You have been assigned to examine the financial statements of Macelle Company for the
year ended December 31, 20x6. Below is the Balance Sheet of the company.

Current assets 700,000 Current liabilities 250,000

Non-current assets 2,000,000 Non-current liabilities 900,000
_________ Stockholders’ Equity 1,550,000
Total Assets 2,700,000 Total liabilities/SHE 2,700,000

In the course of your audit, you discover the following situations:

1. Depreciation of P16,000 for 20x6 on delivery vehicles was not recorded.

2. The physical inventory count on December 31, 20x5, improperly excluded merchandise
costing P95,000 that had been temporarily stored in a public warehouse. Macelle uses
periodic inventory system.

3. The physical inventory count on December 31, 20x6, improperly included merchandise
with a cost of P42,500 that had been recorded as a sale on December 27, 20x6.

4. A collection of P28,000 on account from a customer received on December 31, 20x6

was not recorded until January 2, 20x7.

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

5. In 20x6, the company sold for P18,500 fully depreciated equipment that originally cost
P110,000. The company credited the proceeds from the sale to the Equipment account.

6. During November 20x6, a competitor company filed a patent-infringement suit against

Macelle claiming damages of P1,100,000. The company’s legal counsel has indicated
that an unfavorable verdict is probable and a reasonable estimate of the court’s award
to the competitor is P625,000. The company has not reflected or disclosed this situation
in the financial statements.

7. Macelle has a portfolio of trading securities. No entry has been made to adjust to
market. Information on cost and market value is as follows:

COST MARKET
December 31, 20x5 P 190,000 P 190,000
December 31, 20x6 168,000 164,000

8. At December 31, 20x6, an analysis of payroll information shows accrued salaries of

P36,600. The Accrued Salaries payable account had a balance of P48,000 at December
31, 20x6, which was unchanged from its balance at December 31, 20x5.

9. A large piece of equipment was purchased on January 3, 20x6, for P1,600,000 and was
charged to Repairs Expense. The equipment is estimated to have a service life of 8 years
and no residual value. Macelle normally uses the straight – line depreciation method for
this type of equipment.

10. A P75,000 insurance premium paid on July 1, 20x5, for a policy that expires on June 30,
20x8, was charged to insurance expense.

11. A trademark was acquired at the beginning of 20x5 for P250,000. No amortization has
been recorded since its acquisition. Trademark has an economic life of 5 years.
Questions
1. Current assets at year-end is:
a. P 776,000 b. P 695,000 c. P 669,000 d. P 678,500

2. Non-current assets at year-end is:

a. P 3,498,500 b. P 3,402,500 c. P 3,302,500 d. P 3,298,500

3. Current liabilities at year-end is:

a. P 911,600 b. P 863,600 c. P 286,600 d. P 238,600

4. Non-current liabilities at year-end is:

a. P 1,561,600 b. P 1,525,000 c. P 1,513,600 d. P 900,000

5. The net income of 20x6 is understated by:

a. P 622,400 b. P 603,900 c. P 550,400 d. P 559,900

6. The total amount of fundamental error is:

a. P 176,000 b. P 157,500 c. P 107,500 d. P 25,000

1. Total Stockholders’ Equity at year-end is:

a. P 2,329,900 b. P 2,207,900 c. P 2,227,400 d. P 2,099,400

2. The correcting entry of item “3” assuming the company’s books were already closed is:
a. No adjustment
b. Retained earnings 42,500
Cost of sales 42,500
c. Cost of sales 42,500
Retained earnings 42,500
d. Retained Earnings 42,500

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

Inventory 42,500

Problem 7
Long established a retail business in 20x4. Early in 20x7, Long entered into negotiations
with Short with the intent to form a partnership. You have been asked by Long and Short
to check Long’s books for the past three years to help Short evaluate the earnings potential
of the business.

The net incomes reported on statements submitted to you were as follows:

Year ending 12/31

20x4 20x5 20x6
Income, pretax P63,000 P 70,763 P 61,880

During the examination of the accounts, you found the data given below:

For year ended Dec. 31

20x4 20x5 20x6
Omission from the books

a. Accrued expenses at end of year P 15,120 P 14,658 P 32,368

b. Earned (uncollected) revenue at end
of year 1,400
c. Prepaid expenses at end of year 6,314 8,470 9,842
d. Unearned revenue (collected in advance)
at end of year 4,270

Goods in transit at end of year omitted from

inventory

e. Purchase for which the entry had been made

(ownership passed) 18,270 21,640
f. Purchase for which the entry had not been made
(ownership not passed) 11,970 13,710

Other points requiring considerations:

g. On January 1, 20x6, sold operational equipment for P31,500 that originally cost P35,000
on January 1, 20x4. Cash was debited for P31,500 and equipment was credited for
P31,500. The asset sold was depreciated in 20x4 and 20x5 but not on the 20x6 on the
basis of a 10-year life and no residual value.

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

h. No allowance for bad debts has been set up. An analysis of accounts receivable as of
December 31, 20x6, indicates that the allowance account should have a balance of
P14,000, of which P3,500 relates to 20x4, P4,900 to 20x5, and P5,600 to 20x6.

Questions
1. Adjusted net income of 20x4 is:
a. P 85,834 b. P 82,334 c. P 52,094 d. P 39,466

2. Adjusted net income of 20x5 is:

a. P 81,669 b. P 81,081 c. P 80,157 d. P 76,769

3. Adjusted net income of 20x6 is:

a. P 86,502 b. P 56,682 c. P 51,082 d. P 42,682
4. Inventory at year-end is understated by:
a. P 3,370 b. P 7,930 c. P 21,640 d. P 35,350

5. Accrued expenses at year-end is:

a. Overstated by P17,710 c. Understated by P31,908
b. Understated by P32,368 d. Understated by P17,710

Solution

20x4 20x5 20x6

Unadjusted net income 63,000 70,763 61,880
Item A (15,120) 15,120
(14,658) 14,658
(32,368)
Item B 1,400 (1,400)
Item C 6,314 (6,314)
8,470 (8,470)
9,842
Item D (4,270) 4,270
Item E 18,270 (18,270)
21,640
Item F - - -
Item G 3,500
Item H (3,500) (4,900) (5,600)
Adjusted net income 52,094 81,081 51,082
Answer:
1. C 2. B 3. C 4. C 5. B
Problem 9
The Corporation prepared its own income statement for the years 20x5 and 20x6. The
President was not satisfied and decided to engage the services of a CPA. The following
errors were discovered by the CPA:
___20x5__ ___20x6___
Net income after income tax P 123,250 P 156,250
Inventory understatement at year-end P - P 12,500
Prepaid expenses not taken up 5,000 15,000
Merchandise purchased on account not
Recorded as liability but included in
inventory 25,000
Unearned rent received taken into income 9,000
Accrued taxes unrecorded 20,000 15,000

Questions
1. Net income of 20x5 is:

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

a. P 163,250 b. P 108,250 c. P 83,250 d. P 73,250

2. Net income of 20x6 is:

a. P 199,750 b. P 174,750 c. P 144,750 d. P 142,250

Solution
20x5 20x6
Unadjusted net income 123,250 156,250
12,500
5,000 (5,000)
15,000
(25,000) 25,000
(9,000)
(20,000) 20,000
__________ (15,000)
Adjusted net income 83,250 199,750
Answer:
1. C 2. A
Problem 11
You have been engaged to examine the financial statements of Vince Corporation
for the year ended December 31, 20x6. In the course of your examination, you
have ascertained the following information:

1. Vince uses the allowance method of accounting for uncollectible trade accounts
receivable. The allowance is based upon 3% of past due accounts (over 120 days) and
1% of current accounts as of the close of each month. Due to the changing economic
conditions and climate, the amount of past due accounts has increased significantly, and
management has decided to increase the percentage based on past due accounts to 5%.
The following balances are available:

As of As of
Nov. 30, 20x6 Dec. 31, 20x6

Debit Credit Debit Credit

Accounts Receivable P 390,000 - P 430,000 -
Past due accounts (included 12,00
in Accounts Receivable) 0 - 30,000 -
Allowance for uncol-
lectible accounts - P 28,000 9,000 -

2. The merchandise inventory on December 31, 20x5 did not include merchandise
having a cost of P7,000.00 which was stored in a public warehouse. Merchandise having
a cost of P3,000.00 was erroneously counted twice and included twice in the
merchandise inventory on December 31, 20x6. Vince uses a periodic inventory system.

3. On January 2, 20x6, Vince had a new machine delivered and installed in its new
factory. The cost of this machine was P97,000.00 and the machine is being depreciated
on a straight-line method over an estimated useful life of 10 years. When the new
machine was installed, Vince paid for the following items which were not included in the
cost of the machine, but were charged to repairs and maintenance:
Delivery Expense - P 2,500.00
Installation Costs - 8,000.00
Rearrangement of related Equipment - 4,000.00
P14,500.00

4. On May 3, 20x6, Vince exchanged 500 shares of treasury stock (P50.00 par value
common stock) for a parcel of land to be used as a site for a new factory. The treasury
stock had a cost P70.00 per share when it was acquired and on May 03, 20x6, it had a

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SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

fair value of P80.00 per share. Vince received P2,000.00 when an existing building on
the land was sold for scrap. The land was capitalized at P40,000.00 and Vince recorded
a gain of P5,000.00 on the sale of its treasury stock.

You found the following journal entries in the books:

Land . . . . . . . . . . . . . . . P 40,000.00
Treasury stock . . . . . . . . . . . . . . P 35,000.00
Gain on Sale of treasury stock . . . . . 5,000.00

Cash . . . . . . . . . . . . . . . P 2,000.00
Miscellaneous Income . . . . . . . . . . P 2,000.00

5. On January 02, 20x6, Vince Corporation established a noncontributory defined

benefit plan covering all employees and contributed P 1,000,000.00 to the plan and
charged this amount to the “pension expense”. At December 31, 20x6, Vince determined
that the 20x6 current service and interest costs on the plan amount to P 620,000.00.
The expected and actual rate of return on plan assets for 20x6 was 10%.

Questions
1. The allowance for uncollectible accounts to be reported on the Balance Sheet is:
a. P 14,500.00 b. P 9,000.00 c. P 5,500.00 d. P 4,000.00

2. Doubtful account expense at December 31, 20x6 is:

a. P 14,500.00 b. P 9,000.00 c. P 5,500.00 d. P 4,000.00
3. 20x6 merchandise inventory is:
a. Understated by P 10,000.00 c. Overstated by P 3,000.00
b. Understated by P 4,000.00 d. Overstated by P 4,000.00

4. If no proper correcting entries were made at December 31, 20x5, by how much will
20x5 net income before income taxes be overstated or understated?
a. Understated by P7,000.00 c. Overstated by P 7,000.00
b. Understated by P4,000.00 d. Overstated by P 4,000.00

5. Machinery and equipment account should be reported in the balance sheet (net of
accumulated depreciation) at December 31, 20x6:
a. P 100,350.00 b. P 110,050.00 c. P 111,500.00 d. P 101,800.00

6. Land account should be reported in the balance sheet at December 31, 20x6:
a. P 35,000.00 b. P 33,000.00 c. P 40,000.00 d. P 38,000.00

7. What should be reported at December 31, 20x6 as prepaid pension cost?

a. P 620,000.00 b. P 520,000.00 c. P 1,000,000.00 d. P 480,000.00

8. What amount should be reported as pension expense in 20x6?

a. P 620,000.00 b. P 520,000.00 c. P 1,000,000.00 d. P 480,000.00

9. How much gain should be reported on item no. 4?

a. P 5,000.00 b. P 15,000.00 c. P 10,000.00 d. P 0

10. If no proper correcting entries were made at December 31, 20x6, by how much will
20x6 net income before income taxes be overstated or understated?
a. Understated by P 493,450.00 c. Overstated by P 539,050.00
b. Understated by P 534,050.00 d. Overstated by P 461,550.00

Solution
(1) Doubtful Account Expense 14,500.00
Allowance for D/A 14,500.00
Required allowance as of 12.31.20x6
-on past due accounts (5% x P30,000.00) P 1,500.00
-on current accounts (1% x P400,000.00) 4,000.00
Total P 5,500.00

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 EMILIO AGUINALDO COLLEGE – CAVITE
CAMPUS
SCHOOL OF BUSINESS ADMINISTRATION
INTEGRATED AUDITING THEORIES AND PROBLEMS

Unadjusted “debit” balance of Allowance for D/A 9,000.00

Additional Provision (expense) P14,500.00
(2) a. Merchandise Inventory, 01.01.20x6 7,000.00
Retained Earnings 7,000.00
(to correct understatement of inventory at end of 20x5)
b. Cost of Sales 3,000.00
Merchandise Inventory, 12.31.20x6 3,000.00
(to correct overstatement ending inventory for 20x6)
(3) a. Machinery 14,500.00
Repairs and Maintenance 14,500.00
(to reclassify delivery and installation costs)
b. Depreciation Expense 1,450.00
Accumulated Depreciation 1,450.00
(to provide for depreciation for items not capitalized)
(4) Miscellaneous Income 2,000.00
Gain on Sale of Treasury Stock 5,000.00
Land 2,000.00
APIC-T/S 5,000.00
(to correct client’s entry on the purchase of land)
(5) Prepaid Pension Cost 480,000.00
Pension Expense 480,000.00
(to correct client’s entry in the treatment of prepaid pension cost)
Current Service and interest cost P 620,000.00
Expected return on Plan Asset
(P 1,000,000.00 x 10%) ( 100,000.00)_
Pension Expense P 520,000.00
Reported pension expense 1,000,000.00
Prepaid Pension Cost P 480,000.00
Answer:
1. C 2. A 3. C 4. A 5. A 6. D 7. D 8. B 9. D 10. D

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