PFA 1

Chapter 10 – Prior Period Errors

Ma. Ruby A. Bagsit

Problem 10-1 (IAA)

 
Effective January 1, 2019, King Company adopted the accounting policy of expensing
advertising and promotion costs when incurred.

Previously, advertising and promotion costs applicable to future periods were recorded in
prepaid expenses.

The entity can justify the change which was made for both financial statement and income tax
reporting purposes.

The prepaid advertising and promotion costs totaled P600,000 on December 31 , 2019. The
income tax rate is 30%.

What is the net charge against income for 2019 as a result of the change? 

a. 600,000
b. 180,000
c. 420,000
d. 0

Solution:

The entity committed an error of deferring advertising and promotion costs

A prior period error is not included in profit or loss but treated as an adjustment of the beginning
balance of retained earnings.
Problem 10-2 (IFRS)
 
Harbor Company events during 2019:
• It was decided to write 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? 

a. 2,500,000
b. 1,500,000
c. 1,000,000
d. 0

Solution:

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 write off of the inventory of Pl,000,000 is included in profit or loss for 2019 because this is a
change in accounting estimate.
Problem 10-3 (AICPA Adapted)
 
Universal Company failed to accrue warranty cost ofP500,000 on December 31, 2018.

In addition, a change from straight line to accelerated depreciation made at the beginning of 2019
resulted in a cumulative effect of P400,000 on retained earnings.

What pretax amount should be reported as prior period error in 2019?

a. 500,000
b. 900,000
c. 400,000
d. 0

Solution:

Only the unrecorded warranty cost of P500,000 on December 31, 2018 should be accounted for
as a prior period error.
The change in depreciation method in accounting estimate.
Problem 10-4 (IFRS)
 
Extracts from the statement of financial position of Animus Company showed the following:

December 31, 2020 December 31, 2019

Development costs 8,000,000 5,800,000
Amortization (1,800,000) (1,200,000)

The capitalized development costs relate to a single project that commenced in 2017.
It has now been discovered that one of the criteria for capitalization has never been met.

1. What amount of pretax adjustment is required to restate retained earnings on January 1, 2020?

a. 6,200,000
b. 1,600,000
c. 4,600,000
d. 0

2. What amount of the development costs should be expensed in 2020?

a. 5,800,000
b. 6,200,000
c. 1,600,000
d. 0

Solutions:

Question 1:
Development costs December 31, 2019 5,800,000
Amortization (1,200,000)
Carrying amount December 31, 2019 4,600,000

The entity committed and error in capitalizing the development costs

Thus, the carrying amount of P4,200,000 on December 31, 2019 is treated as prior period error in
the statement of retained earnings for 2020.
Question 2:

The remainder of the carrying amount of development costs on December 31, 2019 should be
expensed in 2020.

Development costs December 31, 2020 8,000,000

Amortization (1,800,000)
Carrying amount December 31, 2020 6,200,000
Carrying amount December 31, 2019 (4,200,000)
Remaining Carrying amount December 31, 2019 1,600,000
Problem 10-5 (IFRS)
 
In reviewing the draft financial statements for the year ended December 31 , 2020, Bituin
Company decided that market conditions were such that the provision for inventory obsolescence
on December 31 , 2020 should be increased by P3,000,000.

If the same basis of calculating inventory obsolescence been applied on December 31 , 2019, the
provision would have been PI higher than the amount recognized in the statement of
comprehensive income

1. What adjustment should be made to the net income of 2020?

a. 6,200,000 decrease
b. 1,600,000 increase
c. 4,600,000 decrease
d. 0 increase

2. What adjustment should be made to the net income of 2019 presented as a comparative figure
in the 2020 financial statements?

a. 1,800,000 decrease
b. 3,000,000 increase
c. 3,000,000 decrease
d. 0

Solutions:

Question 1:

The increase in the provision for inventory obsolescence on December 31, 2020 is deducted from
the net income of 2020.

Question 2:

The increase in the provision for inventory obsolescence in 2019 is ignored because this is
considered a change in accounting estimate.
Problem 10-6 (IFRS)
 
Samar Company reported the following events during the year ended December 31, 2020:

● A counting error relating to the inventory on December 31, 2019 was discovered.

This required a reduction in the carrying amount of inventory at that date of P2,000,000

● The provision for uncollectible accounts receivable on December 31, 2019 P500,000.

During 2020, P800,000 was written off related to the' December 31, 2019 accounts
receivable.

● The income tax rate is 30%.

What adjustment is required to restate retained earnings on January l, 2020?

a. 1,400,000
b. 2,000,000
c. 2,500,000
d. 0

Solution:

The reduction in the carrying amount of inventory on December 31, 2019 of is a prior period
error to be presented net of tax in the statement of retained earnings for 2020.

Prior period error 2,000,000

Income Tax 30% c 2,000,000 (600,000)
Net adjustment to retained earnings 1,400,000

The provision for uncollectible accounts receivable is a change in accounting estimate and
therefore has no effect on the retained earnings.

The change in accounting estimate should be currently and prospectively.

Problem 10-7 (AICPA Adapted)
 
After the issuance of the 2019 financial statements, Narra Company discovered a computational
error of P150,000 in the calculation of the December 31, 2019 inventory.

The error resulted in a PI 50,000 overstatement in the cost of goods sold for the year ended
December 31, 2019.

In October 2020, the entity paid the amount ofP500,000 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
I , 2020?

a. 150,000 credit
b. 105,000 credit
c. 350,000 debit
d. 245,000 debit

Solution:

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 eamings should be kicreased and credited directly.

Prior period error January 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
Problem 10-8 (IFRS)
 
Natasha Company reported net income ofP700,000 for 2020. The entity declared and paid
dividend of P 150,000 in 2020.

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

net income for 2019 was P600,000 and the entity declared and paid dividend ofP300,000 in2019.

In 2020, after the 2019 financial statements were approved for is-AE, the entity discovered an
error in the December 3 1, 2018 financial

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

a. 1,300,000
b. 1,400,000
c. 1,650,000
d. 1,950,000

Solution:

Retained earnings January 1, 2019 1,100,000

Net income for 2019 600,000
Dividend declared and paid in 2019 (300,000)
Retained earnings December 31, 2019 1,400,00
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 1,300,000
Problem 10-9 (AICPA Adapted)
 
While preparing the 2019 financial statements, Dek Company discovered computational errors in
the 2017 and 2018 depreciation expense.

These errors resulted in overstatement of each year's income by P100,000, net of income tax.

The following amounts were in the previously issued financial statements:

2017 2018
Retained earnings, January 1 2,000,000 2,800,000
Net Income 800,000 600,000
Retained earnings, December 31 2,800,000 3,400,000

The net income for 2019 is correctly reported at P700,000.

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

a. 3,900,000
b. 4,100,000
c. 4,300,000
d. 4,000,000

Solution:

Retained earnings January 1, 2019 3,400,000

Prior period error:
Underdepreciation in 2017 and 2018 100,000 x 2 (200,000)
Corrected beginning balance 3,200,00
Net income for 2019 700,000
Retained earnings December 31, 20219 3,900,000
Problem 10-10 (AICPA Adapted)
 
On January 1, 2019, Raven 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 ai the residual value at
P100,000.

The entity. Used the straight-line method of depreciation and is subject to a 30% income tax
missed.

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

a. 1,659,000
b. 1,029,000
c. 1,050,000
d. 1,680,000

Solution:

Machine incorrectly expensed 2,100,000

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 1,050,000

Cost 2,100,000
Residual value (100,000)
Depreciable amount 2,000,000

The amount of P I is a prior period error directly credited to retained earnings because net
income of prior years was understated.

Journal entry on January I, 2019

Machinery 2,100,000
Accumulated depreciation 600,000
Retained earnings 1,050,000
Income tax payable 450,000