NAME: _________________________________
AA31 – Auditing in Specialized Industry
Correction of Errors
Part I – Theories. Supply the best answer.
1. At year-end, an entity ordered merchandise for resale. The merchandise
was shipped FOB Shipping Point at year-end and the goods arrived early
next year. The entity did not record the purchase in the current year and
did not include the goods in the ending inventory. The effects on the
financial statements for the current year were
a. Income and owners’ equity were correct, liabilities were incorrect,
assets were correct.
b. Income and owners’ equity were correct, assets and liabilities were
incorrect.
c. Income, assets, liabilities, and owners’ equity were correct.
d. Income, assets, liabilities, and owners’ equity were incorrect.
2. Which of the following should not be reported retroactively?
a. Use of an unacceptable accounting principle and changing to an
acceptable accounting principle.
b. Correction of an overstatement of ending inventory made in prior year.
c. Use of an unrealistic accounting estimate and changing to a realistic
estimate.
d. Change from a good faith but erroneous estimate to a new estimate.
3. At the end of the current year, special insurance costs, incurred but
unpaid, were not recorded. If these insurance costs were related to work
in process, what is the effect of omission on accrued liabilities and
retained earnings, respectively in the current year-end statement of
financial position?
a. No effect and No effect
b. No effect and Overstated
c. Understated and No effect
d. Understated and Overstated
4. Which of the following errors could result in an overstatement of both
current assets and shareholders’ equity?
a. An understatement of accrued sales commissions.
b. Noncurrent note receivable principal is misclassified as current asset.
c. Annual depreciation on manufacturing machinery is understated.
d. Holiday pay expense for administrative employees is misclassified as
manufacturing overhead.
5. At the end of the current year, an entity failed to accrue sales commission
during the current year but paid in the next year. The error was not
repeated in the next year. What was the effect of the error on current
year-end working capital and retained earnings, respectively?
a. Overstated and Overstated
b. No effect and Overstated
c. No effect and No effect
d. Overstated and No effect
6. If ending inventory is understated, the effect is to
a. Overstate the net purchases.
b. Overstate the gross margin.
c. Overstate the cost of goods available for sale
d. Overstate the cost of goods sold.
7. If the beginning inventory is overstated, the effect is to
a. Overstate net purchases.
b. Overstate gross margin.
c. Overstate cost of goods available for sale.
d. Understate cost of goods sold.
8. The overstatement of ending inventory in the current year will cause
a. Retained earnings to be understated in the current year-end statement
of financial position.
b. Cost of goods sold to be understated in the income statement of next
year.
c. Cost of goods sold to be overstated in the income statement of the
current year.
d. Statement of financial position not to be misstated in the next year-
end.
9. At the middle of the year, an entity paid for insurance premium for the
current year and debited the amount to prepaid insurance. At year-end,
the bookkeeper forgot to record the amount expired. In the financial
statements prepared at year-end, the omission
a. Overstates owner’s equity
b. Understates assets
c. Understates net income
d. Overstates liabilities
10. If at the end of current reporting period, an entity erroneously
excluded some goods from ending inventory and also did not record purchase
of these goods, these errors would cause
a. The ending inventory to be overstated
b. The retained earnings to be understated
c. No effect on net income, working capital, and retained earnings
d. Net income to be understated
11. When the current year’s ending inventory is overstated
a. The current year’s cost of goods sold is overstated
b. The current year’s total assets are understated
c. The current year’s net income is overstated
d. The next year’s income is overstated
12. An overstatement of ending inventory in the current period would result
in income of the next period being:
a. Overstated
b. Understated
c. Correctly stated
d. The answer cannot be determined from the information.
13. Which would result if the current year’s ending inventory is understated
in the cost of goods sold calculation
a. Cost of goods sold will be overstated
b. Total assets would be overstated
c. Net income would be overstated
d. Retained earnings would be overstated
14. If the beginning inventory in the current year was overstated, net
income for the current year will be
a. Understated and assets are correctly stated
b. Understated and assets are overstated
c. Overstated and assets are overstated
d. Understated and assets are understated
15. Which of the following would cause income to be overstated in the period
of occurrence?
a. Overestimating bad debts expense
b. Understating beginning inventory
c. Overstated purchases
d. Understated ending inventory
16. Failure to record the expired amount of rent expense would not
a. Understate expense
b. Overstate net income
c. Overstate owners’ equity
d. Understate liabilities
17. Failure to record accrued salaries at year-end results in
a. Overstated retained earnings
b. Overstated assets
c. Overstated liabilities
d. Understated retained earnings
18. Failure to record depreciation at year-end results in
a. Understated income
b. Understated assets
c. Overstated expense
d. Overstated assets
19. Which of the following is a counterbalancing error?
a. Understated depletion expense
b. Bond premium under-amortized
c. Prepaid expense adjusted incorrectly
d. Overstated depreciation expense
20. Accrued expense will not self-correct next year
a. Accrued expense not recognized at year-end
b. Accrued revenue not recognized at year-end
c. Depreciation expense overstated for the year
d. Prepaid expense not recognized at year-end
Part II – Journal Entries. Prepare the necessary journal entries on the given
items below.
Item number 1:
In your audit of Maraming Mali Inc. for the period of 12/31/2026, you have
discovered the following errors:
2025
Inventory was understated by 200,000.
The entity failed to record depreciation amounting to 46,000.
No entry was made for its Sales Commission Expense amounting to 500,000.
2026
Ending Inventory was recorded at cost of 2,400,000. It’s NRV is
2,600,000
The entity failed to record purchases amounting to 300,000. Terms are
FOB Seller; it was shipped last 12/25/2026.
The entity failed to record purchases amounting to 230,000. Terms are
FOB Destination; it was received last 1/10/2027.
Item number 2:
Forgetful Recording Company encountered the following errors.
2025
As per records, FRC has an accrued income of 356,250. The entity forgot to
record half of the accrued income already received.
On 06/01/2025, the entity paid for its annual rental for 1 year amounting to
350,000. The entity’s accountant forgot to make any necessary adjusting
entries. It was recorded under asset method.
2026
The entity presented the following information for it’s Allowance for
Doubtful Accounts:
Beginning 200,000
Doubtful Accounts Expense 300,000
Recovery 20,000
Write-off ( 50,000)
Ending Balance 470,000
The company used percentage of credit sales method in computing for its
Doubtful Accounts Expense. However, as per aging, Allowance for Doubtful
Accounts is 500,000.
On 04/01/2026, the entity received 375,000 from its client. This is on
account of the latter’s annual subscription to the entity’s magazine. The
accountant forgot to make any necessary adjusting entry. Initial record
provide that it was recorded under liability method.