ANSWER KEY – QUIZ 2 (CORRECTION OF ERRORS)

STRAIGHT PROBLEM (42 POINTS)

Requirement (1) – 34 POINTS:

Adjusting journal entries at December 31, 2016. In case no adjusting entry is necessary, indicate under the
account names column the words “No required AJE.”

SOLUTION GUIDE:
No. Date Account Names Dr. Cr.
201
6
(1A Dec. 31 No required AJE
)

(1B Dec. 31 Merchandise Inventory, January 1, 2016 48,000

)
Retained Earnings 48,000

(2A Dec. 31 No required AJE

)

(2B Dec. 31 Retained Earnings 14,000

)
Sales 14,000

(3A Dec. 31 No required AJE

)

(3B Dec. 31 Retained Earnings 24,000

)
Purchases 24,000

(4A Dec. 31 Accumulated Depreciation - Building 30,000

)
Retained Earnings 30,000

(4B Dec. 31 Retained Earnings 12,000

)
Accumulated Depreciation- Equipment 12,000

(5A Dec. 31 No required AJE

)

(5B Dec. 31 Interest Revenue 500

)
Retained Earnings 500

(6A Dec. 31 No AJE is required

)

(6B Dec. 31 Utility Expense 200

)
Retained Earnings 200

(7A Dec. 31 No required AJE

)

(7B Dec. 31 Retained Earnings 1,200

)
Advertising Expense 1,200

1
 (8A Dec. 31 No required AJE
)

(8B Dec. 31 Miscellaneous Revenue 300

)
Retained Earnings 300

(9) Dec. 31 Retained Earnings 7,200

Allowance for Doubtful Accounts 7,200

2. Compute the audited balances of the following – 8 POINTS:

A. Corrected Net Income for the year 2014 204,100
B. Corrected Net Income for the year 2015 120,100
D. Corrected Retained Earnings as of January 1, 2016 225,500

SUPPORTING COMPUTATIONS:
Retained
Net Income Net Income Earnings
No. Errors 2014 2015 1/1/2016

Unadjusted balances 131,100 172,500 204,900

1A Merchandise inventory as of December 31, 2014
was over valued by P 36,000. (36,000) 36,000 0

1B Merchandise inventory as of December 31, 2015

was undervalued by P 48,000. 48,000 48,000

2A Sales of merchandise in 2014 of P 50,000 were

taken up in the records in 2015. 50,000 (50,000) 0

2B Sales on account in 2016 of P 14,000 were taken

up in 2015. (14,000) (14,000)

3A Purchases of merchandise in 2015 of P 40,000

were taken up in the records in 2014. 40,000 (40,000) 0

3B Purchases on account in 2015 of P 24,000 were

taken up in 2016. (24,000) (24,000)

4A Depreciation of the building during 2014 was

overstated by P 30,000. 30,000 30,000

4B Depreciation of the office equipment during 2015

was understated by P 12,000. (12,000) (12,000)

5A End of 2014 accrued commission revenue of P

5,000 was not recorded. 5,000 (5,000) 0

5B End of 2015 accrued interest revenue of P 1,000

was recorded as P 500. 500 500

6A End of 2014 accrued wages of P 12,000 was not

recorded. (12,000) 12,000 0

6B End of 2015 accrued utility expenses of P 300 was

recorded as P 500. 200 200

7A Prepaid insurance expense as of December 31,

2014 of P 3,500 was not recognized. 3,500 (3,500) 0

7B Prepaid advertising expense as of December 31,

2015 of P 2,400 was recorded as P 3,600 (1,200) (1,200)

8A Unearned rent revenue as of December 31, 2014

of P 7,500 was not recorded. (7,500) 7,500 0

2
8B Unearned miscellaneous revenue as of December
31, 2015 of P 700 was recorded as P 1,000. 300 300

9 Adjustment for the doubtful accounts for 2015 of P

7,200 was omitted in the records. These accounts
were written off during 2016. (7,200) (7,200)

Adjusted/Corrected balances 204,100 120,100 225,500

3
MULTIPLE CHOICE PROBLEM (16 POINTS)
Choose the correct answer among the given choices. Supporting computation is not necessary. Write the letter of
your choice on the answer sheet provided. Use CAPITAL LETTERS.

MCP Question Your

NO. No. Answer
1 C
2 A
3 1 A
2 A
4 A
5 1 D
2 D
3 C

MC Problem 1
During 2016, Paul Company discovered that the ending inventories reported in the financial statements were
incorrect by the following amounts: Year 2014 – P 60,000 understated; Year 2015 – P 75,000 overstated. Paul uses
the periodic inventory system to ascertain the year-end quantities that are converted to peso amounts using the FIFO
cost method. Prior to any adjustments for these errors and ignoring income taxes, Paul’s retained earnings at
January 1, 2016 would be:
A. Correct
B. P 15,000 understated
C. P 75,000 overstated
D. P 135 overstated

SOLUTIONS:
The January 1, 2016 Retained Earnings Balance is also the December 31, 2015 balance. Understatement of ending
inventory will also understate net income and retained earnings. Same direct effect in case ending inventory is
overstated. The effect in next year after the year of error is the opposite or inverse in net income because the ending
inventory of last year will become the beginning inventory of next year. Any effect of the error in the beginning
inventory is the opposite effect in net income. Thus, its effect in retained earnings is zero.

Year 2014 Year 2015

Errors Net Income RE Net Income RE

2014 Ending Inventory - understated 60,000 60,000 (60,000) 0

2015 Ending Inventory - overstated (75,000) (75,000)
Total Effect 60,000 60,000 (75,000) (75,000)
(C)

MC Problem 2
After the issuance of its 2015 financial statements, Terry, Inc., discovered a computational error of P 150,000 in the
calculation of its December 31, 2015 inventory. The error resulted in a P 150,000 overstatement in the cost of goods
sold for the year ended December 31, 2015. Ignoring income taxes, in the 2016 financial statements, the December
31, 2015 retained earnings balance, as previously reported, should be adjusted by:
A. P 150,000 credit
B. P 150,000 debit
C. No adjustment is necessary
D. Cannot be determined

SOLUTIONS:
Overstatement of cost of sales will result to understatement of net income and retained earnings in the year of error.

Year 2015
Errors Net Income RE

2015 Cost of Sales overstatement 150,000 150,000

Credit to R/E
(A)

MC Problem 3
JPR, Inc. is a corporation using the calendar-year accounting period. Its financial statements for the years 2016 and
2015 contain errors as follows:

Year 2016:
Merchandise inventory, ending – P 2,000 understated
Depreciation expense – P 1,600 understated

4
Year 2015:
Merchandise inventory, ending – P 6,000 overstated
Depreciation expense – P 5,000 overstated

1. Assume that the proper correcting entries were made at December 31, 2015. By how much will the 2016 net
income be overstated or understated?
A. P 400 understated
B. P 400 overstated
C. P 2,400 understated
D. P 3,600 understated

SOLUTIONS:

Year 2015 Year 2016

Errors Net Income RE Net Income RE

Year 2015:
Merchandise inventory, ending - overstated corrected corrected 0 0
Depreciation expense - overstated corrected corrected 0 0

Year 2016:
Merchandise inventory, ending - understated 2,000 2,000
Depreciation Expense - understated (1,600) (1,600)
Total Effect 400 400
(A)

2. Assume that no correcting entries were made at December 31, 2015 or December 31, 2016, and that no
additional errors occurred in 2017. By how much will working capital at December 31, 2017 be overstated or
understated?
A. P 0
B. P 2,000 overstated
C. P 4,000 overstated
D. P 1,000 understated

SOLUTIONS:
Ending inventory of December 31, 2016 no longer exists at December 31, 2017 based on the FIFO cost flow
assumption. Therefore, the understatement of inventory ending at December 31, 2016 has no effect in the working
capital at the end of 2017. Depreciation will not affect the working capital because this is related to non-current asset
(PPE). Working capital is the difference between current assets and current liabilities. Among the given, only the
merchandise inventory will affect working capital because this is part of the current asset.

Year 2015 Year 2016 Year 2017

Net Income RE Net Income WC

Year 2015:
Merchandise inventory, ending - overstated (6,000) (6,000) 6,000 0
Depreciation expense - overstated 5,000 5,000 0 0

Year 2016:
Merchandise inventory, ending - understated 2,000 0
Depreciation Expense - understated (1,600) 0
Total Effect (1,000) (1,000) 6,400 0
(A)

MC Problem 4
Barry, Inc. is a calendar year corporation whose financial statements for the year 2015 and 2016 included errors as
follows:

Year 2015:
Ending inventory – P 15,000 overstated
Depreciation expense – P 12,500 overstated

Year 2016:
Ending inventory – P 5,000 understated
Depreciation expense – P 4,000 understated

Assume that purchases were recorded correctly and that no correcting entries were made at December 31, 2015 or
at December 31, 2016. Ignoring income taxes, by how much would Barry’s retained earnings be retroactively
adjusted at January 1, 2017?
A. P 13,500 increase
B. P 3,500 decrease
C. P 1,500 decrease

5
D. P 1,000 increase

SOLUTION:
The January 1, 2017 Retained Earnings Balance is also the December 31, 2017 balance.

Year 2015 Year 2016

Errors Net Income RE Net Income RE

Year 2015:
Ending inventory – overstated (15,000) (15,000) 15,000 0
Depreciation expense – overstated 12,500 12,500 0 12,500

Year 2016:
Ending inventory – understated 5,000 5,000
Depreciation expense –understated (4,000) (4,000)
Total Effect (2,500) (2,500) 16,000 13,500
(A)

MC Problem 5
The December 31 year-end financial statements of Gladiola Company contained the following errors:

Year 2015:
Ending inventory – P 3,000 understated
Depreciation expense – P 600 understated

Year 2016:
Ending inventory – P 2,700 overstated

Insurance premiums of P 2,250 were paid in 2015 covering the years 2015, 2016 and 2017. The whole amount was
charged to administrative expense on 2015.

Also in December 31, 2016, a fully depreciated machinery was sold for P 4,800 but the cash sale was recorded only
in January, 2017.

There were no other errors during 2015 and 2016 and no correcting entries were made for any of the errors.

Ignore income tax considerations.

1. What is the total effect of the errors on 2016 net income?

A. P 900 overstatement
B. P 1,050 overstatement
C. P 1,350 understatement
D. P 1,650 overstatement

SOLUTION FOR (1) AND (3):

The January 1, 2017 Retained Earnings Balance is also the December 31, 2017 balance.

Year 2015 Year 2016

Errors Net Income RE Net Income RE

Year 2015:
Ending inventory – understated 3,000 3,000 (3,000) 0
Depreciation expense –understated (600) (600) 0 (600)
Administrative expense - overstated 2,250 2,250 0 2,250
Insurance expense - understated (750) (750) 0 (750)

Year 2016:
Ending inventory – overstated (2,700) (2,700)
Insurance expense - understated (750) (750)
Other income - understated 4,800 4,800
Total Effect 3,900 3,900 (1,650) 2,250
(D) (C)
#1 #3

6
2. Due to the errors, the amount of Gladiola Company’s working capital at December 31, 2016 resulted in
A. P 1,500 overstatement
B. P 2,100 understatement
C. P 2,250 understatement
D. P 2,850 understatement

SOLUTION:
Year 2016
Errors Net Income WC

Year 2015:
Ending inventory – understated (3,000) 0
Depreciation expense –understated 0 0
Administrative expense - overstated 0 0
Insurance expense - understated 0 0

Year 2016:
Ending inventory – overstated (2,700) (2,700)
Insurance expense - understated (750) 0
Other income - understated 4,800 0

Other asset accounts – 2016:

Prepaid Insurance (P 2,250 x 1/3) 750
Cash (from sale of machinery) 4,800
Total Effect (1,650) 2,850
(D)
#2

3. What is the total effect of the errors on Gladiola Company’s retained earnings balance at December 31, 2016?
A. P 1,350 understatement
B. P 1,500 understatement
C. P 2,250 understatement
D. P 1,900 overstatement

SOLUTION:
See solution in number (1)