AUDITING PROBLEMS

PROBLEM 1
1) Sir Benzington failed to recognized accruals and prepayments during its first year of operations. The pre-tax earnings,
accruals and prepayments at the end of the year were:
Pre-tax profit 5,000,000
Items not recognized at year-end were as follows:
Prepaid insurance 200,000
Accrued wages 250,000
Rent revenue collected in advance 300,000
Interest receivable 100,000
The correct amount of pre-tax profit should be
A. 5,250,000 B. 5,000,000 C. 4,950,000 D. 4,750,000

PROBLEM 2
You were engaged by Panic Company to audit its financial statements for the first time. In examining the books, you noted
that certain adjustments had been overlooked at the end of 2021 and 2022. You also discovered that other items had been
improperly recorded. These omissions and other errors for each year were summarized:
December 31, 2022 December 31, 2021
Salaries payable 780,000 873,600
Interest receivable 213,000 259,200
Prepaid insurance 307,800 384,000
Advances from customers 561,000 470,400
(collection from customers had been recorded as sales
but should have been recognized as advances from
customers because goods were not shipped until the
following year)
Machinery 522,000 564,000
(capital expenditures had been recorded as repairs but
should have been charged to Machinery; the
depreciation rate is 10% per year, but depreciation in the
year of expenditure is to be recognized at 5%)
Questions: Considering the above date and the result of the audit, answer the following:
1. What is the total effect of the errors on the 2021 net income?
A. Understated by P1,236,600 C. Overstated by P80,400
B. Understated by P775,800 D. Overstated by P165,000
2. What is the total effect of the errors on the 2022 net income?
A. Understated by P320,100 C. Overstated by P324,300
B. Understated by P376,500 D. Overstated by P380,700
3. What is the total effect of the errors on the company’s working capital at December 31, 2022?
A. Understated by P265,800 C. Overstated by P820,200
B. Understated by P301,800 D. Overstated by P119,400
4. What is the total effect of the errors on the balance of the company’s retained earnings at December 31, 2022?
A. Overstated by P885,900 C. Understated by P155,100
B. Overstated by P930,900 D. Understated by P265,800
5. The necessary adjusting journal entry for the error in the recording capital expenditures on Machinery as of
December 31, 2021 would include:
A. A credit to retained earnings of P535,800 C. A debit to depreciation expense of P54,300
B. A credit to accumulated depreciation of P82,500 D. A debit to machinery of P522,000

PROBLEM 3
In line with your audit with Inozent One, Inc. financial statements, the company accountant presented to you the balance
sheet that follows. You reviewed the client’s accounting records and books based thereon. You discovered that books of
accounts are in agreement in the said balance sheet as presented below:
INOZENT ONE, INC.
STATEMENT OF FINANCIAL POSITION
DECEMBER 31, 2022
Asset Liabilities and Shareholder’s Equity
Cash 80,000 Accounts payable 32,000
Accounts receivable 160,000 Notes payable 64,000
Notes receivable 48,000 Capital stock 160,000
Inventories 400,000 Retained earnings 432,000
Total 688,000 Total 688,000
Audit notes:

a. Further review and investigation of the company’s books revealed the following omissions and errors which were not
corrected during the year of errors:
2019 2020 2021 2022
Deferred expense 14,400 11,200 8,000 9,600
Deferred income 6,400 4,800
Accrued expense 3,200 1,200 1,600 800
Accrued income 2,000 2,400
Ending inventory – overstated 112,000 128,000
Ending inventory – understated 96,000 144,000

b. A P50,000 routinary repair cost incurred on its equipment at the beginning of 2019 was charged to the equipment
account and was depreciated using straight-line method over the remaining useful life of the equipment which was 5
years

c. A P90,000 major repair cost which enhanced the production capacity of one of its equipment at the beginning of 2021
was charged to repairs expense. Remaining useful life of the related production equipment was 3 years.

No dividends were declared during the year 2019 to 2022 and no adjustments were made to retained earnings. The
company’s reported the following net income:
Year 2019 2020 2021 2022
Net income 120,000 88,000 104,000 120,000

Questions: Considering the above date and the result of the audit, answer the following: (DISREGARD TAX)

1. What is the correct net income (loss) in 2019?

A. 35,200 B. 198,400 C. 187,200 D. 227,200
2. What is the correct net income (loss) in 2020?
A. 290,400 B. (29,600) C. (115,600) D. (125,600)
3. What is the correct net income (loss) in 2021?
A. 88,800 B. 158,800 C. 89,600 D. 120,800
4. What is the correct net income (loss) in 2022?
A. 372,000 B. 392,000 C. 390,400 D. (152,000)
5. What is the net adjustment to retained earnings as of January 1, 2022?
A. 81,600 debit B. 120,000 credit C. 121,600 debit D. 121,600 credit
6. What is the net adjustment to working capital as of December 31, 2022?
A. 144,000 B. 150,400 C. 154,500 D. 163,200

PROBLEM 4
You have been engaged to examine the financial statements of Tupac Corporation for the year 2023. The bookkeeper who
maintains the financial records has prepared all of the unadjusted financial statements for the Corporation since its
organization on January 2, 2021. You discover numerous errors that have been made in these statements. The client has
asked you to compute the correct income for the three years 2021 through 2023 and to prepare a corrected balance sheet
as of December 31, 2023. In the course of your examination you discover the following:

a. The Corporation includes sales taxes collected form customers in the Sales account. When sales tax collections for a
month are remitted to the taxing authority on the 15th of the following month, the Sales Tax Expense account is
charged. All sales are subjected to a 3% sales tax. Total sales plus sales taxes for 2021 through 2023 were P495,430,
P762,200 and P875,500, respectively. The totals of the Sales Tax Expense account for the three year were P12,300,
P21,780 and P26,640.

b. Furniture and fixtures were purchased on January 2, 2021 for P12,000 but no portion of the cost has been charted to
depreciation. The Corporation wishes to use the straight-line method for these assets which have been estimated to
have a life of 10 years and no salvage value.

c. In January 2021 installation costs of P5,700 on new machinery were charged to Repairs Expense. Other costs of this
machinery of P30,000 were correctly recorded and have been depreciated using the straight-line method with an
estimated life of 10 years and no salvage value.

d. An account payable of P8,000 for merchandise purchased on December 23, 2021 was recorded in January 2022. This
merchandise was not included in inventory at December 31, 2021.

e. Merchandise having a cost of P6,550 was stored in a separate warehouse and was not included in the December 31,
2022 inventory, and merchandise having a cost of P2,180 was included twice in the December 31, 2023 inventory. The
Corporation uses a periodic inventory method.

f. The year-end salary accrual of P1,925 on December 31, 2023 has not been recorded.
g. A check for P1,895 from a customer to apply to this account was received on December 31, 2021 but was not
recorded until January 2, 2022.

h. The Corporation has used the direct write-off method of accounting for bad debts. Accounts written off during each of
the three years amount to P1,745, P2,200 and P5,625, respectively. The Corporation has decided that the Allowance
for Doubtful Accounts at the end of each of the three years are: P6,100, P8,350 and P9,150.

Assume that the net income computed before all adjustments and corrections was P180,000 for 2021, P212,000 for 2022
and P252,000 for 2023.

Questions:
1. What is the adjusted net income in 2021?
A. 175,700 B. 181,800 C. 163,400 D. 176,270
2. What is the adjusted net income in 2022?
A. 214,110 B. 208,010 C. 216,240 D. 201,010
3. What is the adjusted net income in 2023?
A. 237,635 B. 240,335 C. 240,715 D. 239,915
4. What is the net effect of these errors on total assets as of December 31, 2023?
A. 10,940 over B. 7,360 under C. 9750 over D. 4,390 over
5. What is the net effect of these errors on the total shareholders’ equity as of December 31, 2023?
A. 4,025 under B. 7,725 over C. 14,275 over D. 13,085 over

PROBLEM 5
You audited the financial statements of PIS Corp. for the first time in 2022. The company started its operation in early 2020.
Upon investigation, you discovered the following information:

a. The company reported the net income at P104,000, P140,000 and P160,000 in 2020, 2021, and 2022, respectively.

b. The company consistently omitted the following:

2020 2021 2022
Prepaid insurance 2,000 4,000 6,000
Accrued salaries 7,500 6,200 8,300
Unearned rent 5,000 6,000 7,000
c. Deliveries of merchandise to customers at December 31 of each year end were recorded as sales upon collection the
following year. The corresponding sales price of the said deliveries were P15,000, P12,000 and P14,000 in 2020,
2021, and 2022, respectively. Inventory counts were conducted on December 31 of each year before any deliveries
and receipts were made on the said date. Sales were made consistently at a gross profit rate of 40% of sales.
d. Purchases in transit FOB destination at each year end amounted to P5,000 and P7,000 in 2021 and 2022
respectively. These were recorded as purchases upon receipt of the corresponding invoices in December. The in-
transit inventories were properly excluded from the inventory balances at year-end.
e. The company incurred pre-operating and organization costs totaling P80,000 in early 2020 which it had capitalized as
intangible asset and amortized over 5 years.
f. Improvements were made and completed early in 2020 on the leased office space costing P100,000 which it had
capitalized to a leasehold improvements account and had depreciated over its life which was 10 years. The term of the
non-cancellable lease however is 5 years without renewal option.

Questions: Considering the above data and the result of the audit, determine the following:
1. What is the correct net income in 2020?
A. 44,500 B. 34,500 C. 35,500 D. 25,500
2. What is the retroactive adjustment to the 2022 beginning retained earnings?
A. (68,200) B. (66,400) C. (59,200) D. (49,200)
3. What is the correct net income in 2022?
A. 170,500 B. 149,100 C. 144,500 D. 167,700
4. What is the effect of the errors to the 2021 working capital?
A. (3,400) B. (13,600) C. 8,800 D. 1,600
5. If the errors remained uncorrected by the end of 2022, the effect of the errors to the 2022 ending retained earnings
is
A. 58,700 overstated B. 74,700 overstated C. 50,700 overstated D. 52,500 overstated