CHAPTER 10

PRIOR PERIOD ERRORS

Problem 10 – 1 (IAA)
Effective January 1, 2018, 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 totalled P600,000 on December 31, 2018. The
income tax rate is 30%.

What is the net charge against income for 2018 as a result of the change?
a. 600,000
b. 180,000
c. 420,000
d. 0

Solution 10 – Answer d
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 reported the following events during 2018:

*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, 2017.

What pre – tax amount should be reported as prior period error in the financial statements for
the year ended December 31, 2018?

a. 2,500,000
b. 1,500,000
c. 1,000,000
d. 0
Solution 10 – 2 Answer b

Only the unrecorded sale of P1,500,000 on December 31, 2017 is treated as prior period error in
the financial statements for 2018.

The write off of the inventory of P1,000,000 is included in profit or loss for 2018.

Problem 10 – 3 (AICPA Adapted)

Universal Company failed to accrue warranty cost of P500,000 on December 31, 2017.

In addition, a change from straight line to accelerated depreciation made at the beginning of
2018 resulted in a cumulative effect of P400,000 on retained earnings.

What pre – tax amount should be reported as prior period error in 2018?

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

Solution 10 – 3 Answer a
Only the unrecorded warranty cost of P500,000 on December 31, 2017 should be accounted for
as a prior period error.

The change in depreciation method is a change in accounting estimate.

Problem 10 – 4 (IFRS)

Extracts from the statement of financial position of Animus Company showed the following:

December 31, 2019 December 31, 2018

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 2016.

It has now been discovered that one of the criteria for capitalization has never been met.

1. What amount of pre – tax adjustment is required to restate retained earnings on January 1,
2019?
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 2019?
a. 5,800,000
b. 6,200,000
c. 1,600,000
d. 0

Solution 10 – 4
Question 1 Answer c
Development costs – December 31, 2018 5,800,000
Amortization (1,200,000)
Carrying amount – December 31, 2018 4,600,000

The entity committed an error in capitalizing development costs.

Thus, the carrying amount of P4,600,000 on December 31, 2018 is treated as a prior period error
in the statement of retained earnings for 2019.

Question 2 Answer c
The remainder of the carrying amount of the development costs on December 31, 2019 should
be expensed in 2019.

Development costs – December 31, 2019 8,000,000

Amortization (1,800,000)
Carrying amount – December 31, 2019 6,200,000
Carrying amount – December 31, 2018 4,600,000
Remaining carrying amount 1,600,000

Problem 10 – 5 (IFRS)
In reviewing the draft financial statements for the year ended December 31, 2019. Bituin
Company decided that market conditions were such that the provision for inventory
obsolescence on December 31, 2019 should be increased by P3,000,000.

If the same basis of calculating inventory obsolescence had been applied on December 31, 2018,
the provision would have been P1,800,000 higher than the amount recognized in the statement
of comprehensive income.

1. What adjustment should be made to the net income of 2019?

a. 3,000,000 decrease
b. 3,000,000 increase
c. 1,200,000 decrease
d. 1,200,000 increase
2. What adjustment should be made to the net income of 2018 presented as a comparative
figure in the 2019 financial statements?
a. 1,800,000 decrease
b. 1,800,000 increase
c. 3,000,000 decrease
d. 0

Solution 10 – 5
Question 1 Answer a
The increase in the provision for inventory obsolescence on December 31, 2019 of P3,000,000 is
deducted from the net income of 2019.

Question 2 Answer d
The increase in the provision for inventory obsolescence in 2018 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, 2019:

* A counting error relating to the inventory on December 31, 2018 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, 2018 was P500,000.

During 2019, P800,000 was written off related to December 31, 2018 accounts receivable.

* The income tax rate is 30%.

What adjustment is required to restate retained earnings on January 1, 2019?

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

Solution 10 – 6 Answer a
The reduction in the carrying amount of inventory on December 31, 2018 of P2,000,000 is a prior
period error to be presented net of tax in the statement of retained earnings for 2019.

Prior period error 2,000,000

Income tax (30% x 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 retained earnings.

The change in accounting estimate should be treated currently and prospectively.

Problem 10 – 7 (AICPA Adapted)

After the issuance of the 2018 financial statements, Narra Company discovered a computational
error of P150,000 in the calculation of the December 31, 2018 inventory.

The error resulted in a P150,000 overstatement in the cost of goods sold for the year ended
December 31, 2018.

In October 2020, the entity paid the amount of P500,000bnin settlement of litigation instituted
against it during 2019.

The income tax rate is 30%.

In the financial statements for 2019, what is the adjustment of the retained earnings on January
1, 2019?
a. 150,000 credit
b. 105,000 credit
c. 350,000 debit
d. 245,000 debit

Solution 10 – 7 Answer b
The inventory on December 31, 2018 was understated resulting to overstatement of cost of
goods sold and understatement of net income for 2018.

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

Inventory – January 1, 2019 150,000

Retained earnings 105,000
Income tax payable – 30% 45,000

The settlement of the litigation in 2019 is included in the profit or loss of 2019.

Litigation loss 500,000

Cash 500,000

Problem 10 – 8 (IFRS)
Natasha Company reported net income of P700,000 for 2019. The entity declared and paid
dividend of P150,000 in 2019.
In the financial statements for the year ended December 31, 2018, the entity reported retained
earnings of P1,100,000 on January 1, 2018.

The net income for 2018 was P600,000 and the entity declared and paid dividend of P300,000 in
2018.

In 2019, after the 2018 financial statements were approved for issue, the entity discovered an
error in the December 31, 2017 financial statements.

The net effect of the error was a P650,000 overstatement of net income for the year ended
December 31, 2017 due to under depreciation.

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

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

Solution 10 – 8 Answer a
Retained earnings – January 1, 2018 1,100,000
Net income for 2018 600,000
Dividend declared and paid in 2018 (300,000)
Retained earnings – December 31, 2018 1,400,000
Net income for 2019 700,000
Prior period error in 2017 due to under depreciation (650,000)
Dividend declared and paid in 2019 (150,000)
Retained earnings – December 31, 2019 1,300,000

Problem 10 – 9 (AICPA Adapted)

While preparing the 2018 financial statements, Dek Company discovered computational errors in
the 2016 and 2017 depreciation expense.

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

The following amounts were reported in the previously issued financial statements:

2016 2017
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 2018 is correctly reported at P700,000.

What is the correct balance of retained earnings on December 31, 2018?
a. 3,900,000
b. 4,100,000
c. 4,300,000
d. 4,000,000

Solution 10 – 9 Answer a
Retained earnings – January 1, 2018 3,400,000
Prior period error: Under depreciation in 2016 and
2017 (100,000 x 2) (200,000)
Corrected beginning balance 3,200,000
Net income for 2018 700,000
Retained earnings – December 31, 2018 3,900,000

Problem 10 – 10 (AICPA Adapted)

On January 1, 2018, Raven Company discovered that it had incorrectly expensed a P2,100,000
machine purchased on January 1, 2015.

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 December 31, 2018 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 10 – 10 Answer c

Machine incorrectly expensed 2,100,000

Unrecorded depreciation for 2015, 2016 and 2017 (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 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, 2018
Machinery 2,100,000
Accumulated depreciation 600,000
Retained earnings 1,050,000
Income tax payable 450,000