CORRECTION OF ERRORS

ERRORS

According to Philippine Standards on Auditing No. 240, “error refers to an unintentional misstatement in
financial statements including the omission of an amount or a disclosure, including:

1. A mistake in gathering or processing data from which financial statements are prepared;
2. An incorrect accounting estimate arising from oversight or misinterpretation of facts;
3. A mistake in the application of accounting principles relating to measurement, recognition,
classification, presentation or disclosure.”

FRAUD

Fraud refers to the intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal
advantage.

Prior Period Errors

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or
more prior periods arising from a failure to use or misuse of reliable information that:
(a) was available when financial statements for those periods were authorized for issue; and
(b) could reasonably be expected to have been obtained and taken into account in the preparation and
presentation of those financial statements.

Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies,
oversights or
misinterpretations of facts, and fraud.

Accounting Treatment of Prior Period Error

According to PAS 8 par 42, “an entity shall correct material prior period errors retrospectively in the first
set of financial statements authorized for issue after their discovery by:

(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or

(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets,
liabilities and equity for the earliest prior period presented.

Limitations on retrospective restatement

A prior period error shall be corrected by retrospective restatement except to the extent that it is
impracticable to determine either the period-specific effects or the cumulative effect of the error.
When it is impracticable to determine the period-specific effects of an error on comparative information for
one or more prior periods presented, the entity shall restate the opening balances of assets, liabilities and
equity for the earliest period for which retrospective restatement is practicable (which may be the current
period).
 When it is impracticable to determine the cumulative effect at the beginning of the current period of an
error on all prior periods, the entity shall restate the comparative information to correct the error
prospectively from the earliest date practicable.

Basic Concepts in Correction of Errors

Effect in the Net

Errors affecting net income: Income Relationship
If Sales are overstated Overstated Direct
If Cost of sales is overstated Understated Inverse
If Expenses are overstated Understated Inverse

Errors affecting cost of sales: Effect in Cost of Sales Relationship

If Beginning inventories are
overstated Overstated Direct
If Net purchases are overstated Overstated Direct
If Ending inventories are overstated Understated Inverse

Working capital
Working capital is the capital of a business that is used in its day-to-day trading operations, computed as
the current assets minus the current liabilities.

Effect in working
Errors affecting working capital: capital Relationship
If the current assets are overstated Overstated Direct
If the current liabilities are overstated Understated Inverse

TYPES OF ERRORS
1. Balance sheet or statement of financial position errors
2. Income statement errors
3. Combined statement of financial position and income statement errors
a. Counterbalancing errors
b. Non-counterbalancing errors

Statement of Financial Position or Balance Sheet Errors

Statements of Financial Position or balance sheet errors affect only the presentation of an asset, liability,
or stockholders’ equity account.
When the error is discovered in the error year, the company reclassifies the item to its proper position.
If the error in a prior year is discovered in a subsequent period, the company should restate the statement
of financial position of the prior year for comparative purposes.

INCOME STATEMENT ERRORS

Income statement errors are errors affecting only the income statement accounts and may include
improper classification of revenues or expenses.
A company must make a reclassification entry when it discovers the error in the error year.
If the error discovered pertains to a prior year, the company should restate the income statement of the
prior year for comparative purposes.

Since these errors involve two nominal accounts, net income and retained earnings during the period are
unaffected.

Problem No. 1: You discovered the following errors in connection with your examination of the financial
statements of Dell Corp

1. Interest expenses of Php20,000 in 2020 was erroneously debited to rent expense

2. Accounts receivable of Php30,000 was erroneously debited to notes receivable.
The following data were extracted from the financial statements of Dell Corp;
2020 2021
Net Income 200,000150,000
Working Capital 600,000400,000
RE, end of the year 100,000250,000

Based on the above data, determine the ff: Net income, Working Capital, Retained earnings end of 2020
and 2021. Give the PAJE.

Combined Statement of Financial Position and Income Statement Errors

Errors affecting both the statement of financial position and income statement can be classified as:
1. Counterbalancing errors and
2. Non-counterbalancing errors

Counterbalancing Errors
Counterbalancing errors are errors that will offset or be corrected over two accounting periods.

Examples include the following:

Omissions of the following:

Deferred expense (or Prepayments under the expense method.)
Deferred income (Precollection under the revenue method.)
Accrued Expenses
Accrued Revenues

Overstatement Or Understatement of the following:

Sales not recorded in the first year and subsequently recorded the following year (or vice versa).
Purchases not recorded in the first year and subsequently recorded the following year (or vice versa).
Error affecting ending inventory

Problem 2: You discovered the following errors in connection with your examination of the financial
statements of the Jane Corporation:
1) Accrued interest expense of ₱18,000 was not recorded at the end of 2016.
2) Accrued rent receivable of ₱25,000 was not recorded at the end of 2016.
3) The company paid one-year insurance premium of ₱24,000 effective March 1, 2016. The entire amount
was debited to expense account and no adjustment was made at the end of 2016.
4) The company leased a portion of its building for ₱36,000. The term of the lease is one year ending
April 1, 2017. Collection of rent was credited to rent revenue account. At the end of 2016, no entry was
made to take up the unearned portion of the amount collected.

The following data were extracted from the financial statements of Jane Corporation:

2016 2017
Net income 200,000 160,000
Working capital 180,000 260,000
RE, end of the year 200,000 360,000

Based on the above data, determine the following:

1. Net Income in 2016

2. Working capital, end of 2016

3. Retained earnings, end of 2016

4. Net Income in 2017

5. Working capital, end of 2017

6. Retained earnings, end of 2017

7. Prepare adjusting entries assuming errors were discovered in (a) 2016, (b) 2017, and (c) 2018.

PROBLEM NO. 3 – COUNTERBALANCING ERRORS

You discovered the following errors in connection with your examination of the financial statements of
the Girlie Corporation:
1) Purchase of merchandise on account on December 24, 2016 amounting to ₱50,000 was not recorded
until it was paid in January 2017. The merchandise was properly included in the ending inventory in
2016.
2) Sale of merchandise on account on December 30, 2016 amounting to ₱60,000 was not recorded until it
was collected in January 2017. The merchandise was properly excluded in the ending inventory in 2016.
3) On December 31, 2016, the ending inventory was understated by ₱30,000.

Based on the above data, determine the following:

2016 2017
Net income 200,000 160,000
Working capital 180,000 260,000
RE, end of the year 200,000 360,000

1. Net Income in 2016

2. Working capital, end of 2016

3. Retained earnings, end of 2016

4. Net Income in 2017

5. Working capital, end of 2017

6. Retained earnings, end of 2017

7. Prepare adjusting entries assuming errors were discovered in (a) 2016, (b) 2017, and (c) 2018.

PROBLEM NO. 4 – Assignment to be submitted next meeting

Kingston Company’s December 31, year-end financial statement contained the following errors

-An insurance premium of Php150,000 was prepaid in 2020 covering the years 2020, 2021, and
2022. The same was charged to expense in full in 2020.
- Accrued interest Income of Php 36,000 was not recorded in 2020
- A payment amounting to Php30,000 to an Advertising company representing marketing services
availed was recorded as Salaries and Wages.
- Unrecorded interest expense amounting to Php 50,000 was not recorded in 2020 and subsequently
paid in February 28, 2021
Based on the above answer the provide the impact on the following accounts
• 2020 Net Income, Retained Earnings, Working Capital
• 2021 Net Income, Retained Earnings, Working Capital
• Provide PAJE for 2020 and 2021

NON-COUNTERBALANCING ERRORS
Non-counter balancing errors do not offset in the next accounting period. Therefore, companies must
make correcting entries, even if they have closed the books.

Examples:

1. Prepayments under the asset method

2. Precollection under the liability method
3. Error in recording depreciation
4. Improper capitalization of expense
5. Improper expensing of capital expenditures
6. Error in recording of proceeds of sale of an asset (e.g. PPE) as other income

PROBLEM NO. 3 (NONCOUNTERBALANCING ERRORS)

You discovered the following errors in connection with your examination of the financial statements of
the Joy Corporation:
1) The Company paid one- year insurance premium of ₱36,000 effective March 1, 2017. The entire
amount was debited to asset account and no adjustment was made at the end of 2017.
2) The company leased a portion of its building for ₱30,000. The term of the lease is one year ending
April 30, 2018. Collection

of rent was credited to unearned rent revenue account. At the end of 2017, no entry was made to take up
the earned portion of the amount collected.
3) Depreciation expense in 2017 was overstated by ₱12,000.
4) Improvements on building amounting to ₱200,000 had been charged to expense on January 1, 2017.
Improvements have a life of 4 years.
5) On January 1, 2017, an equipment costing ₱60,000 was sold for ₱20,000. At the date of sale, the
equipment had an accumulated depreciation of ₱48,000. The cash received was recorded as other income
in 2017.
6) Repairs expense on the building amounting to ₱20,000 had been charged to the building account on
January 1, 2017.
Depreciation expense has been recorded in 2017 to 2018 based on the 4 year remaining useful life of the
building.
The following data were extracted from the financial statements of Joy Corporation:

2017 2018
Net income 200,000 160,000
Working capital 180,000 260,000
RE, end of the year 200,000 360,000

Questions:
Based on the above data, determine the following:
1. Net income, Working Capital, Retained Earnings end for 2017, 2018, 2018
2. Prepared adjusting entries assuming errors were discovered in 2017, 2018, 2019

PROBLEM NO 4.
You discovered the following errors in connection with your examination of the financial statements of
the Joy Corporation:

1) The Company paid one- year insurance premium of ₱36,000 effective March 1, 2017. The entire
amount was debited to asset account and no adjustment was made at the end of 2017.
2) The company leased a portion of its building for ₱30,000. The term of the lease is one year ending
April 30, 2018. Collection of rent was credited to unearned rent revenue account. At the end of 2017, no
entry was made to take up the earned portion of the amount collected.
3) Depreciation expense in 2017 was overstated by ₱12,000.
4) Improvements on building amounting to ₱200,000 had been charged to expense on January 1, 2017.
Improvements have life of 4 years.
5) On January 1, 2017, an equipment costing ₱60,000 was sold for ₱20,000. At the date of sale, the
equipment had an accumulated depreciation of ₱48,000. The cash received was recorded as other income
in 2017.
6) Repairs expense on the building amounting to ₱20,000 had been charged to the building account on
January 1, 2017.
Depreciation expense has been recorded in 2017 to 2018 based on the 4 year remaining useful life of the
building.
The following data were extracted from the financial statements of Joy Corporation:

2016 2017
Net income 200,000 160,000
Working capital 180,000 260,000
RE, end of the year 200,000 360,000

Based on the above data, determine the following

1. Net income in 2017
a. ₱194,000 b. ₱206,000 C. ₱216,500 D. ₱325,000

2. Working capital, end of 2017

a. ₱170,000 c. ₱196,500
b. ₱192,000 d. ₱202,500

3. Retained earnings, end of 2017

a. ₱194,000
b. ₱206,000
c. ₱216,500
d. ₱325,000

4. Net income in 2018

a. ₱119,000 c. ₱159,000
b. ₱154,000 d. ₱161,500

5. Working capital, end of 2018

a. ₱254,000
b. ₱260,000
c. ₱ 276,000
d. ₱267,500

6. Retained earnings, end of 2018

a. ₱350,000 c. ₱366,000
b. ₱360,000 d. ₱444,000

PROBLEM 5. Assignment to be submitted next meeting

The first audit of the books of Luzon Company was made for the year ended December 31, 2020. 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 2018, 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 2019, the company failed to accrue sales salaries of P90,000.

c. In 2020, the company wrote off P174,000 of inventory considered to be obsolete; this loss was
charged directly to Retained Earnings

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

e. Insurance for a 12-month period purchased on November 1 of this year was charged to insurance
expense in the amount of Php 5,280 because “the amount of the check is about the same every
year.

Requirements: Identify the impact on Net Income and working capital on 2018, 2019 and 2020. Provide
the Entry Made, Should Be entry and Proposed Journal Entry.

Problem 6.

During the audit of a new client, Cialette Company, for the year ended December 31, 2020, you learned of
the following transactions between Cialette Company and another client, financiers, Inc.:

1. Cialette completed construction of a warehouse building on its own land in June, 2006 at a cost of P2
million. Construction was financed by a construction loan from the Capital Development Bank.

2. On July 1, 2006, Financiers, Inc. bought the building from Cialette for P2 million, which Cialette
used to discharge its construction loan.

3. On July 1, 2006, Financiers, Inc. borrowed P2 million from Capital Development Bank, to be repaid
quarterly over four years plus interest at 9%. A mortgage was placed on the building to secure the
loan, and Cialette signed as a guarantor of the loan.

4. On July 1, 2006, Cialette signed a noncancelable 20-year lease of the building from Financiers, Inc.
The lease specified that Cialette would pay P242,700 per year for 20 years, payable in advance on
each July 1, and granted an option exercisable at the end of the 20-year period, permitting Cialette to
either (a) purchase the building for P240,000 or (b) renew the lease for an additional 15 years at
P30,000 per year and purchase the building for P20,000 at the end of the renewal period. The lease
specified that P12,000 of the annual payment would be for insurance, taxes, and maintenance for the
following 12 months; if the lease should be renewed, P10,000 of each annual payment would be for
insurance, taxes and maintenance.

5. The building has a useful life of 40 years and is to be depreciated under the straight-line method
(assume no salvage value).

6. Cialette and financiers negotiated the lease for a return of 10%. You determine that the present value
of all future lease payment is approximately equal to the sales price and that the sale-and-leaseback
transaction is in reality only in financing arrangement.

For the December 31, 2020, balance sheet of Cialette company, prepare schedules computing the balances
for the following items:
1. The prepaid insurance, taxes, and maintenance at December 31, 2020 is:
2. The cost of the warehouse building at December 31, 2020 is:
3. The current liabilities arising from the lease at December 31, 2020 is:
4. The long-term liabilities arising from the lease at December 31, 2020 is:
5. The accumulated depreciation of the warehouse building at December 31, 2020 is:

Problem 7.
A CPA is engaged by the Sony Corporation in 20020 to examine the books and records and to make
whatever corrections are necessary. An examination of the accounts discloses the following:
a. Dividends had been declared on December 15 in 2018 and 2019 but had not been entered in the
books until paid.
b. Improvements in building and equipment of P9,600 had been debited to expense at the end of
April 2017. Improvements are estimated to have an 8-year life. The company uses the straight-
line method in recording depreciation and computes depreciation to the nearest month.
c. The physical inventory of merchandise had been understated by P3,000 at the end of 2018 and by
P4,300 at the end of 2019.
d. The merchandise inventories at the end of 2019 and 2020 did not include merchandise that was
then in transit and to which the company had title. This shipments of P3,800 and P5,500 were
recorded as purchases in January of 2020 and 2018, respectively.
e. The company had failed to record sales commissions payable of P2,100 and P1,700 at the end of
2019 and 2020, respectively.
f. The company had failed to recognized supplies on hand of P1,200 and P2,500 at the end of 2005
and 2006, respectively.

The Retained Earnings account showed the following postings:

Date Item Debit Credit
Jan-01 Balance 81,000
2018
Dec-31 Net income for year 18,000
Jan-10 Dividends paid 15,000
2019 Mar-06 Stock sold – excess over par 32,000
Dec-31 Net loss for year 11,200
Jan-10 Dividend paid 15,000
2020
Dec-31 Net loss for year 12,400

Questions:
1. Corrected net income of 2018
a. P 19,800 b. P 15,600 c. P 13,600 d. P 16,800

2. Corrected net loss of 2019

a. P 16,000 b. P 14,000 c. P 12,000 d. P 10,000

3. Corrected net loss of 2020

a. P 16,200 b. P 15,800 c. P 15,200 d. P 12,800

4. Adjusted retained earnings at December 31, 2018

a. P 109,200 b. P 106,400 c. P 94,600 d. P 85,000

5. Adjusted retained earnings at December 31, 2019

a. P 71,200 b. P 69,000 c. P 67,600 d. P 65,000
6. Adjusted retained earnings at December 31, 20020
a. P 51,400 b. P 49,800 c. P 49,000 d. P 48,200

Problem 8. Assignment to be submitted next meeting

A partial trial balance of Josh Alejandro Corporation is as follows on December 31, 2020:

Dr. Cr.
Supplies on hand 13,500
Accrued salaries and wages 7,500
Interest receivable on investments 25,500
Prepaid insurance 450,000
Unearned rent -
Accrued interest payable 75,000

Additional adjusting data:

a. A physical count of supplies on hand on December 31, 2020, totaled P5,500.

b. Through oversight, the Accrued Salaries and Wages account was not changed during
2006. Accrued salaries and wages on 12/31/20 amounted to P22,000.

c. The interest receivable on investments account was also left unchanged during 2006.
Accrued interest on investments amounts to P21,750 on 12/31/20.

d. The unexpired portions of the insurance policies totaled P325,000 as of December 31,
2020.

e. P140,000 was received on January 1, 2019, for the rent of a building for both 2019 and
2020. 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
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