UST AMV – COLLEGE OF ACCOUNTANCY

CA5106 - CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

I - CHANGE IN ACCOUNTING POLICY

1. During 2019, DGP Company decided to change from the FIFO inventory valuation to the weighted
average method. The income tax rate is 30%.

FIFO Weighted Average

January 1, inventory P7,100,000 P7,700,000
December 31, inventory 7,900,000 8,200,000

What amount should be reported in the cumulative effect of the change in accounting policy for 2019?

Answer: P420,000 increase in retained earnings

Weighted average inventory – January 1 P7,700,000

FIFO inventory – January 1 7,100,000
Cumulative effect P 600,000

Cumulative effect after tax (P600,000 – 30% tax) P 420,000

The change from FIFO to weighted average is a change in accounting policy. The cumulative effect of the
change in accounting policy is an adjustment of retained earnings.

Inventory 600,000
Retained earnings 420,000
Income Tax Payable 180,000

2. FTC Company had used the FIFO method of inventory valuation since it began operations in 2016. The
entity decided to change to the weighted average method for measuring inventory at the beginning of
2019. The income tax rate is 30%.

The following schedule shows year-end inventory balances:

Year FIFO Weighted Average

2016 P4,500,000 P5,400,000
2017 7,800,000 7,100,000
2018 8,300,000 7,800,000

What amount should be reported for 2019 as the cumulative effect of the change in accounting policy?

Answer: P350,000 decrease in retained earnings

Weighted average inventory – Dec. 31, 2018 P7,800,000

FIFO inventory – Dec. 31, 2018 8,300,000
Decrease in inventory P 500,000

Cumulative effect after tax (P500,000 – 30% tax) P 350,000

The adjustment on January 1, 2019 to reflect the change in inventory method is:

Retained earnings (70% x P500,000) 350,000

Income tax payable (30% x P500,000) 150,000
Inventory 500,000

Since the retained earnings account is a debit, it is shown as a deduction.

The cumulative effect of a change in inventory method is determined by considering only the ending
inventory of the immediately preceding year which in this case is 2018.

The inventory balances in 2016 and 2017 are ignored because the effect on net income is
counterbalancing.
3. During 2019, PTS Company changed from the cost recovery method to the percentage of completion
method. The tax rate is 30%.

The entity revealed the following gross income under the cost recovery and percentage of completion
method:
2017 2018 2019
Cost recovery method P950,000 P1,250,000 P1,400,000
Percentage of completion 1,600,000 1,900,000 2,100,000

How should this accounting change be reported in 2019?

Answer: increase in retained earnings of P910,000

Cumulative gross income for 2017 and 2018 – percentage of completion P3,500,000
Cumulative gross income for 2017 and 2018 – cost recovery ( 2,200,000)
Cumulative increase P1,300,000
Tax effect (P1,300,000 x 30%) 390,000
Addition to retained earnings on January 1, 2019 P 910,000

Journal entry on January 1, 2019:

Construction in progress 1,300,000

Retained earnings 910,000
Income Tax Payable 390,000

II - CHANGE IN ACCOUNTING ESTIMATE

4. JPHEI Company purchased a machine on January 1, 2016 for P6,000,000. At the date of acquisition,
the machine had a life of six years with no residual value. The machine was depreciated on a straight line
basis.

On January 1, 2019, the entity determined that the machine had a useful life of eight years from the date
of acquisition with no residual value.

What is the depreciation expense of the machine for 2019?

Answer: P600,000

Cost P6,000,000
Accumulated depreciation (6,000,000 / 6 x 3 yrs) ( 3,000,000)
Carrying amount – January 1, 2019 P3,000,000

Depreciation for 2019 (3,000,000 / 5 yrs) P 600,000

Revised life 8 yrs

Years expired 3
Remaining revised life 5 yrs

The procedure for a change in accounting estimate is to allocate the remaining depreciable amount over
the remaining revised life.
5. On January 1, 2015, ATS Company purchased equipment for P4,000,000. The equipment has a useful
life of 10 years and a residual value of P400,000.

On January 1, 2019, the entity determined that the useful life of the equipment was 12 years from the
date of acquisition and the residual value was P480,000.

a. What is the carrying amount of the equipment on January 1, 2019?

b. What is the depreciation of the equipment for 2019?

Answer: a. P2,560,000

Cost – January 1, 2015 P4,000,000

Accumulated depreciation – Jan. 1, 2019
(4,000,000-400,000 /10 x 4 yrs) 1,440,000
Carrying amount – Jan. 1, 2019 P2,560,000

Answer: b. P260,000

Carrying amount – Jan. 1, 2019 P2,560,000

Residual value ( 480,000)
Depreciable amount P2,080,000

Depreciation for 2019 (2,080,000 / 8 yrs) P 260,000

Revised useful life 12 years

Expired 4 years
Remaining useful life 8 years

6. On January 1, 2017, TPS Company purchased for P4,800,000 a machine with a useful life of ten years
and a residual value of P200,000.

The machine was depreciated by the double declining balance and the carrying amount of the machine
was P3,072,000 on December 31, 2018.

The entity changed to the straight line method on January 1, 2019. The residual value did not change.

What is the depreciation expense on this machine for 2019?

Answer: P359,000

Depreciation for 2019

(2,872,000 / 8 yrs remaining) P 359,000

Carrying amount – Jan. 1, 2019 P3,072,000

Residual value ( 200,000)
Depreciable amount P2,872,000

Straight line rate (100% / 10) 10%

Double declining rate (Straight line rate x 2) 20%

Acquisition cost - Jan. 1, 2017 P4,800,000

Accumulated depreciation – Jan. 1, 2019
2017 (20% x 4,800,000) P960,000
2018 (20% x 3,840,000) 768,000 1,728,000
Carrying amount – January 1, 2019 P3,072,000

Under PAS 16, paragraph 61, a change in depreciation method is accounted for as a change in accounting
estimate.
III – PRIOR PERIOD ERRORS

7. JGD Company reported the following events during 2019:

 It was decided to write off P1,000,000 from inventory which was over two years old as it was
obsolete.

 Sales of P1,500,000 had been omitted from the financial statements for the year ended
December 31, 2018.

What pretax amount should be reported as prior period error in the financial statements for 2019?

Answer: P1,500,000

Only the unrecorded sale of P1,500,000 on December 31, 2018 is treated as prior period error in the
financial statements for 2019.

The writeoff of the inventory of P1,000,000 is included in profit or loss for 2019 because this is a change
in accounting estimate.

8. After the issuance of the 2019 financial statements, JEB Company discovered a computational error
of P150,000 in the calculation of the December 31, 2019 inventory.

The error resulted in a P150,000 overstatement in the cost of goods sold for the year ended December
31, 2019.

In October 2020, the entity paid the amount of P500,000 in settlement of litigation instituted against it
during 2020.

The income tax rate is 30%.

In the financial statements for 2020, what is the adjustment of the retained earnings on January 1,
2020?

Answer: P105,000 credit

The inventory on December 31, 2019 was understated resulting to overstatement of cost of goods sold
and understatement of net income for 2019.

Thus, the retained earnings should be increased and credited directly.

Inventory – Jan. 1, 2020 150,000

Retained earnings 105,000
Income Tax Payable (30%) 45,000

The settlement of the litigation in 2020 is included in the profit or loss of 2020.

Litigation loss 500,000

Cash 500,000
9. TMC Company reported net income of P700,000 for 2020. The entity declared and paid dividend of
P150,000 in 2020.

In the financial statements for the year ended December 31, 2019, the entity reported retained earnings
of P1,100,000 on Janauary 1, 2019

The net income for 2019 was P600,000 and the entity declared and paid dividend of P300,000 in 2019.

In 2020, after the 2019 financial statements were approved for issue, the entity discovered an error in the
December 31, 2018 financial statements.

The net effect of the error was a P650,000 overstatement of net income for the year ended December 31,
2018 due to underdepreciation.

What amount should be reported as retained earnings on December 31, 2020?

Answer: P1,300,000

Retained earnings – Jan. 1, 2019 P1,100,000

Net income for 2019 600,000
Dividend declared and paid in 2019 ( 300,000)
Retained earnings – Dec. 31, 2019 P1,400,000
Net income for 2020 700,000
Prior period error in 2018 due to underdepreciation ( 650,000)
Dividend declared and paid in 2020 ( 150,000)
Retained earnings – December 31, 2020 P 1,300,000

10. On January 1, 2019, FJR Company discovered that it had incorrectly expensed a P2,100,000 machine
purchased on January 1, 2016.

The entity estimated the machine’s original useful life to be 10 years and the residual value at P100,000.

The entity used the straight line method of depreciation and is subject to a 30% income tax rate.

In the 2019 financial statements, what amount should be reported as a prior period error?

Answer: P1,050,000

Machine incorrectly expenses P2,100,000

Unrecorded depreciation for 2016, 2017 and 2018
(2,000,000 / 10 x 3 years) ( 600,000)
Net overstatement of expense 1,500,000
Tax effect (30% x 1,500,000) 450,000
Net understatement of retained earnings P1,050,000

Cost P2,100,000
Residual value ( 100,000)
Depreciable amount P2,000,000

The amount of P1,050,000 is a prior period error directly credited to retained earnings because net income
of prior years was understated.

Journal entry on January 1, 2019

Machinery 2,100,000
Accumulated depreciation 600,000
Retained earnings 1,050,000
Income tax payable 450,000
IV – CORRECTION OF ERROR (BASIC)

11. On January 1, 2019, TCC Company reported retained earnings of P4,000,000.

In 2019, the entity determined that insurance premiums of P900,000 for the three-year period beginning
January 1, 2018 had been paid and fully expensed in 2018. The income tax rate is 30%.

What amount should be reported as corrected retained earnings on January 1, 2019?

Answer: P4,420,000

Retained earnings – January 1, 2019 P4,000,000

Understatement of prepaid insurance – 12/31/2018
(900,000 x 2/3) P600,000
Tax effect (30% x 600,000) 180,000 420,000
Corrected retained earnings – January 1, 2019 P4,420,000

12. BAC Company’s beginning inventory on January 1 was understated by P200,000 and the ending
inventory was overstated by P600,000.

What was the effect of the errors on the cost of goods sold for the current year?

Answer: P800,000 understated

January 1 inventory understated P200,000

December 31 inventory overstated 600,000
Cost of goods sold understated P800,000

If beginning inventory is understated, cost of goods sold is also understated. If ending inventory is
overstated, cost of goods sold is understated.

13. On December 31, 2019, TICL Company sold merchandise for P750,000 to EMP Company. The terms
of the sale were net 30, FOB shipping point.

The merchandise was shipped on December 31, 2019, and arrived at EMP on January 5, 2020.

Due to a clerical error, the sale was not recorded until January 2020 and the merchandise sold at a 25%
mark-up on cost was included in inventory on December 31, 2019.

What was the effect of the errors on cost of goods sold for 2019?

Answer: Understated by P600,000

The December 31, 2019 inventory was overstated.

Therefore, cost of goods sold for 2019 was understated by P600,000 (750,000 / 125%)
14. GRAFIK Company reported the following errors:
2018 2019
Ending inventory P50,000 understated P100,000 overstated
Depreciation expense 150,000 overstated 200,000 overstated

None of the errors were detected or corrected and that no additional errors were made in 2020.

a. What is the net effect of the errors on retained earnings on December 31, 2019?

b. By what amount would current assets on December 31, 2020 be overstated or understated?

Answer: a. P250,000 understated

2018 2019
Ending inventory - 2018 P 50,000 (P 50,000)
Ending inventory – 2019 (100,000)
Depreciation - 2018 150,000 -
Depreciation - 2019 200,000
Net correction to net income P200,000 P 50,000

Net effect on retained earnings (P200,000 + P50,000) P250,000

Answer: b. No effect

The current assets on December31, 2020 are no longer affected because the overstatement of 2019
ending inventory would affect 2020 cost of goods sold. The depreciation error does not affect current
assets.

15. MARIES Company started operations at the beginning of current year. The entity failed to recognize
accruals and prepayments at the end of reporting period.

The income before tax, accrual and prepayments at the end of the current year are:

Income before tax P1,400,000

Prepaid insurance 20,000
Accrued wages 25,000
Rent revenue collected in advance 30,000
Interest receivable 50,000

What amount should be reported as corrected income before tax?

Answer: P1,415,000

Unadjusted income P1,400,000

Prepaid insurance 20,000
Accrued wages ( 25,000)
Rent revenue collected in advance ( 30,000)
Interest receivable 50,000
Corrected income P1,415,000

Guide:
Asset understated – Income understated
Asset overstated – Income overstated
Liability understated – Income overstated
Liability overstated – Income understated
16. In 2020, ABR Company discovered that equipment purchased on January 1, 2018 for P1,000,000 was
expensed at that time.

The equipment should have been depreciated over 5 years with no residual value. The tax rate is 30%.

What is the journal entry in 2020 to correct the error?

Answer:

Equipment 1,000,000
Accumulated depreciation (1,000,000 / 5 x 2) 400,000
Retained earnings (600,000 x 70%) 420,000
Income tax payable 180,000

V – CORRECTION OF ERROR (COMPREHENSIVE)

17. AGG Company provided the following comparative statements of income and retained earnings:

2019 2018
Sales P4,500,000 P4,350,000
Cost of goods sold 2,000,000 2,300,000
Gross income P2,500,000 P2,050,000
Expenses 1,600,000 1,500,000
Income before tax P 900,000 P 550,000
Income tax (30%) 270,000 165,000
Net income P 630,000 P 385,000

Beginning retained earnings P1,450,000 P1,200,000

Net income 630,000 385,000
Dividends ( 200,000) ( 300,000)
Ending retained earnings P1,880,000 P1,285,000

In 2020, AGG Company discovered that ending inventory for 2018 was understated by P100,000 and the
ending inventory for 2019 was overstated by P400,000.

What amount should be reported as corrected retained earnings on December 31, 2019?

Answer: P1,600,000

Retained earnings – December 31, 2019 P1,880,000

Overstatement of 2019 ending inventory
(400,000 – 30% tax) ( 280,000)
Corrected balance – December 31, 2019 P1,600,000

The inventory error in 2018 is counterbalanced in 2019 and therefore has no effect on retained earnings
on December 31, 2019.

end