16-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition

Substantive Tests of Income Statement Accounts 16-3

16-1.a

16-2.d

16-3.Red Company

Requirement (1)

2 0 0 6

2 0 0 5

Reported net income

P 35,000

P 27,000

Subtract ending inventory overstatement

(2,000)

(5,000)

Add beginning inventory overstatement

5,000

Subtract wages payable when incurred

(800)

(700)

Add wages payable when expensed

700

Subtract bad debts

(400)*

(1,300)

Add back prepayments in year recorded as expense

200

500

Subtract prepayments in year expense is incurred

(500)

Correct net income

P 37,200

P 20,500

* P1,700 P1,300

Requirement (2)

2007

Jan.1Retained Earnings4,300

Insurance Expense 200

Inventory2,000

Wages Expense 800

Allowance for Doubtful Accounts1,700

16-4.Orange Corporation

Requirement (1)

(1)

Allowance for Uncollectible Accounts

17,400

Administrative Expenses (37,000 19,600)

17,400

To reflect reduction in loss experience rate.

(2)

Unrealized Holding Loss on Trading Marketable

Securities

19,000

Valuation Allowance

16,000

Retained Earnings

3,000

To reduce marketable securities to market valuation and correct prior years profit.

(3)

Retained Earnings

4,000

Cost of Sales

2,100

Merchandise Inventory

6,100

To adjust for overstatements in opening and closing inventories.

(4)

a.Equipment

12,000

Operating Expenses

1,100

Retained Earnings

10,900

Accumulated Depreciation: Equipment

2,200

To adjust for error in recording of equipment purchase in 2005 and related depreciation for 2005 and 2006.

b.Accumulated Depreciation: Equipment

17,500

Equipment

15,000

Other Income

2,500

To adjust for misposting of equipment sale.

(5)

Prepaid Expenses

900

Operating Expenses

900

Retained Earnings

1,800

To adjust for nonrecognition of prepaid expense in 2005 and 2006.

(6)

Ordinary Shares

60,000

Capital in Excess of Par

60,000

To adjust for capital contributed in excess of par value.

Requirement (2)

Orange Corporation

Computation of Corrected Net Income

For Years Ended December 31, 2006 and 2005

2006

Debit (Credit)

2005

Debit (Credit)

Reported income

P(220,000)

P(195,000)

Change in accounts receivable loss

experience rate

(17,400)

---

Unrealized loss (gain) on marketable securities

19,000

(3,000)

Ending merchandise inventories overstated:

December 31, 2005

(4,000)

4,000

December 31, 2006

6,100

Misposting of equipment purchase:

Decrease in operating expenses 2005

(10,900)

Increase in operating expenses 2006

1,100

Misposting of proceeds of equipment sold

(2,500)

Recognition of prepaid insurance

900

(1,800)

Corrected net income

P(216,800)

P(206,700)

16-5. XOR Corporation

XOR Corporation

Worksheet to Correct Net Profit and Balance Sheet Accounts

From 2004 to 2006

Net Profit

Adjustments to Balance Sheet Accounts

2 0 0 4

2 0 0 5

2 0 0 6

Inventory

Retained

Earnings

Prepaid

Expenses

Prepaid

Income

Accrued

Expenses

Accrued

Income

Unadjusted balance

P 7,500

P 6,500

P 5,500

P25,000

P27,000

(

(

(

(

Add (Deduct) Adjustments

(1)Overvaluation of inventory

2004

(7,000)

7,000

2005

(8,000)

8,000

(2)Undervaluation of inventory

2003

(6,000)

2006

9,000

9,000

9,000

(3)Prepaid expenses omitted at end of year

2003

(900)

2004

700

(700)

2005

500

(500)

2006

600

600

600

(4)Prepaid income omitted at end of year

2004

(400)

400

2006

(300)

(300)

300

(5)Accrued expenses omitted at end of year

2003

200

2004

( 75)

75

2005

(100)

100

2006

( 50)

( 50)

50

(6)Accrued income omitted at end of year

2004

125

(125)

2006

150

150

150

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Adjusted amount

P(5,850)

P 5,550

P22,500

P34,000

P36,400

P 600

P 300

P 50

P 150

16-6.Sun Freight Company

1.aP107,700(P112,500 P4,800)

2.cP376,800

3.cP159,000(P204,000 P45,000)

4.aP320,550

5.aP25,000

6.cP125,000

7.aP68,600

8.dP179,650

9.aP703,250

10.aP144,250(P9,500 + P25,000 + P16,250 + P18,250 + P75,250)

CHAPTER

16

SUBSTANTIVE TESTS OF

INCOME STATEMENT ACCOUNTS