ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515

CPA Review Batch 45  May 2023 CPA Licensure Examination

FINANCIAL ACCOUNTING & REPORTING / AUDITING PRACTICE S. IRENEO  G. MACARIOLA  C. ESPENILLA  J. BINALUYO

RETAINED EARNINGS
Retained Earnings
The more common items that either increase or decrease Accumulated Profits and Losses/Retained Earnings are:
1. Net income (loss)
2. Prior period adjustments (error corrections and certain changes in accounting principle)
3. Dividends out of earnings (cash, property, liability and share)
4. Adjustment as a result of quasi-reorganization
5. Appropriation or restriction of retained earnings
6. Reversal of appropriation
7. Loss on share capital (including treasury) transaction

Dividends out of earnings – declaration or distribution of company’s earnings are recognized on the date of
declaration as charge (debit) to the accumulated profits and losses. However, when shareholder approval is
required for dividends declared prior to balance sheet date, a liability should be recognized only once the annual
general meeting approves the dividends, because before that date the entity does not have a present obligation.
Until that occurs, the dividend is only a contingent liability. If dividends are declared after the balance sheet date
but before the financial statements are authorized for issue, the dividends are not recognized as a liability at the
balance sheet date as they do not meet the criteria of a present obligation in PAS 37. Such dividends are disclosed
in the notes to the financial statements in accordance with PAS 32.

If the dividends are not declared at balance sheet date, no liability is recognized at balance sheet date.

The amount or measure depends on the type of dividends, such as:

Cash dividends – is measured at the face value of the dividends. If the cash dividend is based on the number
of shares outstanding, the charge to retained earnings does not include treasury shares. When it is necessary to
allocate total dividends between ordinary shares and preference shares, the preferential rights of the preference
shares should be first considered and satisfied:
1. Non-cumulative rights – if a dividend is not paid in a particular year, the right to the dividend is lost.
2. Cumulative rights – if a dividend is not declared in a particular year, the right to the dividend is not lost
but carries over to a subsequent year.
3. Nonparticipating rights – after assigning the dividends due on either the cumulative or non-cumulative
rights, any remaining dividend goes to ordinary shareholders.
4. Participating rights - after assigning the dividends due on either the cumulative or non-cumulative rights,
the ordinary shareholders will receive a “like” percentage of par value outstanding, if there is a remainder
of the declared dividends for participation for the preference share and ordinary share, it should be
allocated in proportion to the par value peso outstanding in each class of equity instruments of the entity.

The “like” percentage is the dividend rate of the participating preference share, if there are two or more preference
shares with different rates and both are participating, then the rate or percentage to be used is the lower rate.

Property dividends –an entity should measure the dividend at the fair value of the non-cash asset at the time
of declaration. An entity should recognize the difference between the dividend paid and the carrying amount of
the asset/s distributed in profit or loss. If the property has yet to be distributed, the entity should recognize a
liability based on the fair value of the non-cash asset at the time of declaration. At the end of each reporting
period and at the date of settlement, the entity shall review and adjust the carrying amount of the dividends
payable, with any changes in the carrying amount of the dividends payable recognized in equity as adjustment
to the amount of the distribution. When the entity settles the dividend payable, it shall recognize the difference,
if any, between the carrying amounts of the assets distributed and the carrying amount of the dividend payable
in profit or loss.

Scrip or liability dividends (deferred cash dividends) – are measured at face or present value of the
dividend. If scrip dividends bear interest, the interest portion of the cash payment should be debited to Interest
Expense and should not be treated as dividends.

Share dividends – dividends involving no transfer of cash or any other asset to shareholders but a distribution
of additional shares to existing shareholders. On the distribution of additional shares, distinction is made between
a small and a large share dividend. Small share dividend (represents below 20% outstanding shares) is measured
at the fair market value of the shares on declaration date, while a large share dividend (representing 20% to 25%
of outstanding shares) is measured at the par value of shares.

Prior Period Errors – errors made in the past are discovered and corrected in the current year by an adjustment
to the accumulated profits and losses account referred to as a prior period adjustment. Most errors can occur in
measuring the result of operation and financial status of the enterprise. Some errors can be of mathematical
mistakes, failure to apply appropriate accounting procedures, or misstatement or omission of certain information
and also a change from an accounting principle that is not generally accepted to one that is generally accepted.
Some errors are discovered during the accounting period prior to the closing of books, if this is the case, making
correcting entries directly to the accounts can make correction. These corrections will not affect the accumulated
profits and losses.

Page 1 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

Types of Errors:
a. Counter Balancing/Self-correcting Errors - Some errors go undetected during the current period but they
are offset by an equal misstatement in the subsequent period. When this happens, the under or
overstatement of income in one period is counterbalanced by an equal amount of over or understatement
of income in the next period. After the closing process is completed for the second year, the accumulated
profits and losses account is correctly stated.
Examples of counterbalancing errors are:
i. Omission of Accrued Expenses
ii. Omission of Unearned Income
iii. Omission of Accounts Payable/Purchases
iv. Omissions of Prepaid expenses
v. Omission of Accrued Income
vi. Omission of Accounts Receivables/Sales
vii. Understatement of Ending Inventories
viii. Overstatement of Ending Inventories

b. Non-counter Balancing Errors - If errors of the past are not “counterbalancing”, accumulated profits and
losses will be misstated until a correction is made in the accounting records.
Examples of non-counterbalancing errors are:
i. Capitalization of a revenue expenditure and its corresponding effect on subsequent
depreciation (overstatement)
ii. Charging as an outright expense a capitalizable expenditure and its corresponding effect
on subsequent depreciation (understatement)

Accounting Policies – specific principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting financial statements.

An entity shall change an accounting policy only if the change:

a. is required by a Standard, or
b. results in the financial statements providing reliable and more relevant information

Applying Changes in Accounting Policies:

a. Initial application of a Standard – apply the transitional provision of the Standard, if any
b. If there is no transitional provision, the new accounting policy should apply retrospectively (as if the new
accounting policy had always been applied from the very start). This is done by restating the profit of the
prior year that is presented in the financial statements and adjusting the opening or beginning balance of
the retained earnings of the prior year presented in the financial statements.

Change in Accounting Estimates – an adjustment of the carrying amount of an asset or a liability as a result
of new information or new developments and are not therefore corrections of an error.

Accounting information cannot always be measured and reported precisely. Sometimes for the financial
statements to be reported on a timely basis for decision making, accounting data often must be based on
estimates of future events. The financial statements incorporate these estimates, which are based on the best
professional judgment given the information available at that time. At a later date, however, additional
experience or new facts sometimes make it clear that the estimates need to be revised to reflect the existing
business circumstances. When this happens, a change in accounting estimates happens. Examples of areas for
which changes in accounting estimates are made include the following:
• Uncollectible receivables
• Useful lives of depreciable assets
• Residual values for depreciable assets
• Warranty obligations
The effect of a change in accounting estimate shall be recognized prospectively by including it in the
profit and loss.

Restrictions or Appropriation of Accumulated Profits and Losses – transferring accumulated profits and
losses or retained earnings to appropriation is only a reclassification of earnings so that these reclassified earnings
cannot be declared as dividends, and it is also a way of disclosing in the face or in the notes to financial statement
that the company does not want to distribute the same amount of funds because they are needed for a specific
purpose(s) such as the following:
1. As a legal purpose – the company should appropriate accumulated profits and losses equal to the
remaining cost of treasury share.
2. As a contractual requirement – some bond indentures require appropriation of accumulated profits and
losses at a specified amount over the term of the bond.
3. As a protection of working capital – when it is necessary to maintain a strong current position so the
company must disclose that the working capital is not available for dividend declaration equal to the
amount of appropriation.
4. For existence of possible or expected losses – appropriation may be created for estimated losses arising
from lawsuits, unfavorable contractual obligations, and other contingencies.

Reversal of Appropriation – when the purpose of the appropriation has been met like: when the treasury share
has been re-issued, when bonds are already paid, when there has been a final decision on the lawsuit, when the
asset being constructed has been completed, when contingencies no longer exist, etc. then it would be necessary
to reverse the appropriation back to the accumulated profits and losses.

Page 2 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

Quasi-reorganization – may be accomplished under two accounting procedures such as the following:
1. Deficit reclassification – results solely in eliminating a deficit in retained earnings without restating assets
or liabilities. The procedure is limited to reclassification of a deficit in reported accumulated profits and
losses as a reduction of paid-in capital. (ex. change from par to no-par or from no-par to par; reduction
of par or reduction of stated value and share split)
2. Accounting reorganization – involves restating the assets of the enterprise to their fair values and
liabilities to their present values with the net amount of these adjustments added to or deducted from
the deficit. The balance in the accumulated profits and losses account or retained earnings (debit or credit)
is then closed to other capital account, usually Share Premium Reserve, so that the company has a “fresh
start” with a zero balance in accumulated profits and losses.

FINANCIAL ACCOUNTING & REPORTING - THEORIES

1. The cumulative feature of preference shares
a. limits the amount of cumulative dividends to the par value of the preference shares.
b. requires that preference dividends not paid in any year must be made up in a later year before
dividends are distributed to ordinary shareholders.
c. means that the shareholder can accumulate preference shares until it is equal to the par value of
ordinary shares at which time it can be converted into ordinary shares.
d. enables a preference shareholder to accumulate dividends until they equal the par value of the shares
and receive the shares in place of the cash dividends.
2. Which of the following statements about property dividends is not true?
a. A property dividend is usually in the form of securities of other companies.
b. A property dividend is also called a dividend in kind.
c. The accounting for a property dividend should be based on the carrying value (book value) of the
nonmonetary assets transferred.
d. All of these statements are true.
3. Houser Corporation owns 4,000,000 shares of Baha Corporation. On December 31, 2022, Houser distributed
these shares as a dividend to its shareholders. This is an example of a
a. property dividend. b. share dividend. c. liquidating dividend. d. cash dividend.
4. The balance in Ordinary Share Dividend Distributable should be reported as a(n)
a. deduction from share capital—ordinary.
b. addition to share capital—ordinary.
c. current liability.
d. contra current asset.
5. A feature common to both share splits and share dividends is
a. a transfer to earned capital of a corporation.
b. that there is no effect on total equity.
c. an increase in total liabilities of a corporation.
d. a reduction in the contributed capital of a corporation.
6. Younger Company has outstanding both ordinary shares and nonparticipating, non-cumulative preference
shares. The liquidation value of the preference shares is equal to its par value. The book value per share of
the ordinary shares is unaffected by
a. the declaration of a share dividend on preference payable in preference shares when the market price
of the preference is equal to its par value.
b. the declaration of a share dividend on ordinary shares payable in ordinary shares when the market
price of the ordinary shares is equal to its par value.
c. the payment of a previously declared cash dividend on the ordinary shares.
d. a 2-for-1 split of the ordinary shares.
7. How would the declaration and subsequent issuance of a 10% share dividend by the issuer affect each of the
following when the fair value of the shares exceeds the par value of the shares?
Share Capital Share Premium
a. No effect No effect
b. No effect Increase
c. Increase No effect
d. Increase Increase
8. Which of the following actions or events does not result in an addition to retained earnings?
a. a quasi-reorganization
b. net income for the period
c. correction of an error in which ending inventory was understated in a previous year
d. issuance of a 3-for-1 share split
9. When dividend is declared, an entry is not made on the
a. date of declaration
b. date of record
c. date of payment
d. an entry is made on all of these dates
10. Cash dividends are paid based on the number of shares
a. authorized
b. issued
c. outstanding
d. outstanding less the number of treasury share

Page 3 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

11. A company declared a cash dividend on its ordinary share in December 2021 payable on January 2022.
Retained earnings would
a. increase on the date of declaration
b. not be affected on the date of declaration
c. not be affected on the date of payment
d. decrease on the date of payment
12. A company has not declared or paid dividends on its cumulative preference share in the last three years.
These dividends should be reported
a. in a note to the financial statements c. as a current liability
b. as a reduction in shareholders’ equity d. as a noncurrent liability
13. Unlike share split, a share dividend requires a formal journal entry in the financial accounting records because
a. share dividends increase the relative book value of an individual’s share holdings
b. share dividends increase the shareholders’ equity in the issuing firm
c. share dividends are payable on the date they are declared
d. share dividends represent a transfer from retained earnings to contributed capital
14. The issuer of a 5% ordinary share dividend to ordinary shareholder preferably should transfer from retained
earnings to contributed capital an amount equal to the
a. market value of the shares issued
b. book value of the shares issued
c. minimum legal requirements
d. par or stated value of the shares issued
15. Which of the following statements about scrip dividend is not true?
a. a dividend payable in scrip means that instead of paying the dividend now, the corporation will pay
it at some later date.
b. When the dividend is declared, the company may credit Notes Payable to Shareholders
c. When the dividend is declared, the company may debit Retained Earnings
d. Any interest iccuured in scrip dividends is expensed and not charge to retained earnings
16. How would retained earnings be affected by the declaration of each of the following?
Share Dividend Share Split
a. Decrease Decrease
b. No effect Decrease
c. No effect No effect
d. Decrease No effect
17. A retained earnings appropriations always means the company is
a. setting aside earnings for a specific purpose
b. disclosing managerial policy
c. preventing unusual losses
d. improving the debt-equity ratio
18. A restriction of retained earnings is most likely to be required by
a. incurring a net loss in the current year
b. incurrent a net loss in the prior year
c. purchasing treasury share
d. reissuing treasury share
19. A prior period adjustment should be reflected, net of applicable income taxes, in the financial statements of
a business entity in the
a. retained earnings statement after net income but before dividends
b. retained earnings statement as an adjustment of the opening balance
c. income statement after income from continuing operations
d. income statement as part of income from continuing operations
20. An example of an item that should be reported as a prior period adjustment is the
a. collection of previously written-off accounts receivable
b. payment of taxes resulting from examination of prior year income tax returns
c. correction of error in financial statements of a prior year
d. receipt of insurance proceeds for damages to building sustained in a prior year.
21. The primary purpose of a quasi-reorganization is to give the entity the opportunity to:
a. obtain relief from its creditors
b. revalue understated assets to their fair value
c. eliminate a deficit in retained earnings
d. distribute the share of a newly created subsidiary to the shareholders in exchange for part of their
share in the corporation
22. When an entity goes through a quasi-reorganization, its balance sheet carrying amounts are stated at
a. original cost b. original book value c. replacement cost d. fair value

FINANCIAL ACCOUNTING & REPORTING - PROBLEMS

Problem 1: Westerosi Inc. had the following equity accounts as of December 31, 2021:
Ordinary shares, P10 par value, 180,000 shares issued 1,800,000
Ordinary shares subscribed, 20,000 shares 200,000
10% Preference shares, P5 par value, 100,00 shares issued 500,000
Treasury shares (50,000 ordinary shares) 600,000
Retained earnings 2,500,000
Dividends were last declared and paid on preference shares in 2018.

Page 4 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

How much in dividends should preference and ordinary shareholders, respectively, will receive assuming that the
company declared P520,000 cash dividends under the following independent scenarios:

1. Preference shares are non-cumulative and non-participating.

a. 50,000 & 470,000 b. 150,000 & 370,000 c. 100,000 & 420,000 d. 120,000 & 400,000
2. Preference shares are cumulative but non-participating.
a. 50,000 & 470,000 b. 150,000 & 370,000 c. 130,000 & 390,000 d. 120,000 & 400,000
3. Preference shares are non-cumulative but participating.
a. 50,000 & 470,000 b. 150,000 & 370,000 c. 130,000 & 390,000 d. 205,000 & 315,000
4. Preference shares are cumulative and participating.
a. 50,000 & 470,000 b. 260,000 & 260,000 c. 130,000 & 390,000 d. 205,000 & 315,000

Problem 2: On September 20, 2022, Light Blue Corporation declared the distribution of the following dividend
to its shareholders of record of September 30, 2012.
*Investment in 200,000 share of Astro Corporation share, carrying value P1,200,000; fair market value on
September 20, 2022, P2,900,000; fair market value on September 30, 2022, P3,150,000
The entry to record the declaration of the property dividend would include a debit to retained earnings of:
a. 1,200,000. b. 1,700,000. c. 2,900,000 d. 3,150,000.

Problem 3: The following share dividends were declared and distributed by Fuchsia Corporation:
Percentage of ordinary share
Outstanding at the date of declaration Fair Value Par value
10% P30,000 P20,000
28% P80,000 P51,600
What aggregate amount should be debited to retained earnings for these share dividends?
a. 81,600. b. 91,600. c. 100,000. d. 110,000.

Problem 4: The shareholders’ equity of Yellow Green Company at July 31, 2022, presented below
Ordinary share, par value P20, authorized 400,000 shares
Issued and outstanding 160,000 shares P3,200,000
Share premium 160,000
Retained earnings 650,000
Total Shareholder’s equity P4,010,000
========
On August 1, 2022, the board of directors of Yellow Green declared a 20% share dividend on ordinary share to
be distributed on September 15. The market value of Yellow Green’s ordinary share was P35 on August 1, 2022,
and P38 on September 15, 2022.
What is the amount debited to retained earnings as a result of the declaration and distribution of this share
dividend?
a. 480,000. b. 640,000. c. 840,000. d. 912,000.

Problem 5: On September 1, 2022, Pale Blue Company declared and issued a 15% share dividend. Prior to this
date, Pale Blue had 40,000 shares of P2 par value ordinary share that were both issued and outstanding. The
market value of the Pale Blue’s share was P20 per share at the time the dividend was issued.
The effect of this share dividend to Pale blue’s total shareholders’ equity is:
a. 40,000 decrease. b. 400,000 decrease. c. 400,000 increase. d. no effect.

Problem 6: The shareholders’ equity section of Light Brown Company’s December 31, 2022 statement of financial
position consisted of the following
Ordinary share, P30 par, 200,000 shares issued
and outstanding P6,000,000
Share premium 3,000,000
Retained earnings ( 4,200,000)
On January 1, 2023, Light Brown put into effect a shareholder approved quasi-reorganization by reducing the par
value of the share at P5 and eliminating the deficit against share premium.
Immediately after quasi-reorganization, what amount should Light Brown report as share premium?
a. 3,000,000. b. 3,800,000. c. 8,000,000 d. 1,200,000.

Problem 7: Dark Yellow Company has sustained heavy losses over a period time and conditions warrant that
Dark Yellow undergo a quasi-reorganization at December 31, 2022. Selected statement of financial position items
prior to the quasi-reorganization are as follows:
Inventory was recorded in the accounting records at December 31, 2022, at its fair market value of P6,000,000.
Cost was P6,500,000.
Property, plant and equipment were recorded in the accounting records at December 31, 2022, at P12,000,000,
net of accumulated depreciation. The fair value was P8,000,000.

Page 5 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

Shareholders’ equity on December 31, 2022 was as follows:

Ordinary share, par value P10 per share
authorized, issued and outstanding 700,000 shares P7,000,000
Share premium 1,600,000
Retained earnings (deficit) ( 900,000)
Total Shareholder’s equity P7,700,000
Under the terms of the quasi re-organization, the par value of the ordinary share is to be reduced from P10 per
share to P5 per share

Immediately after the quasi-reorganization has been accomplished, the total shareholders’ equity should be:
a. 4,200,000. b. 3,700,000. c. 3,500,000. d. 3,300,000.

AUDITING PRACTICE
Significant Business Process: Other Business Processes – Financing Cycle

PROBLEM 1: (SHARE SPLIT; CASH DIVIDENDS; SHARE DIVIDENDS)

You were assigned to audit the shareholders’ equity transactions and account balances of Mexico Corp. as of
and for the period ended December 31, 2020. The company reported the following amounts in the shareholders’
equity section of its December 31, 2019, statement of financial position:
Preference shares, P50 par (100,000 shares authorized, 6,000 shares issued) P300,000
Ordinary shares, P10 par (50,000 shares authorized, 25,000 shares issued) 250,000
Share premium – Preference shares 120,000
Share premium – Preference shares 200,000
Share premium – Treasury shares 15,000
Accumulated profits 1,200,000
Treasury shares (ordinary shares), 5,000 shares 120,000
Your test of details of transactions for the current year (2020) revealed the following information:
a. On March 30, the company declared and issued a 20% stock dividend on outstanding ordinary shares.
The fair market value of ordinary shares on this date was at P12.
b. On April 15, the company received subscription for 2,000 shares of preference shares at P80 per share.
c. On June 31, P5 per share dividend on ordinary and P20 per share dividend on preference shares were
declared. These dividends shall be paid on July 15.

d. On July 30, the company declared and issued a 1:2 ordinary shares split-up.

e. On August 1, the company reissued 6,000 treasury shares for an equipment with a fair value at
P55,000.
f. On September 30, the company declared and issued a 10% stock dividend on the outstanding ordinary
shares when the stock is selling for P7.50 per share.
g. On October 1, the company collected in full the subscriptions receivable on preference shares.
h. December 1, the company declared P2.50 dividend on ordinary shares and the P20 per share dividend
on preference shares. These dividends are payable at the beginning of 2020.
i. The company registered a net income for 2020 at P776,000.

Requirements:
1. What is the amount debited to retained earnings as a result of the 20% stock dividends in item a?
2. What is the amount debited to retained earnings as a result of the cash dividends in item c?
3. What is the effect to total stockholders’ equity as a result of the share split in item d?
4. What is the amount debited to retained earnings, if there are any, as a result of the reissuance of treasury
shares in item e?
5. What is the amount debited to retained earnings as a result of the 10% stock dividends in item f?
6. What is the amount debited to retained earnings as a result of the cash dividends in item h?
7. What is the balance of the retained earnings-unappopriated as of December 31, 2020?

PROBLEM 2: (PROPERTY DIVIDENDS)

On October 31, Ethiopia Inc. declared a building as property dividend distributable to stockholders on January 31
of the following year. The building had a carrying value of P1.5M on October 31. The building had a fair market
value of P1.4M on the same date. On Dec. 31 the value of the building further deteriorated and latest estimates
placed the fair value of the building at P1.2M. Cost to dispose the property was consistently estimated at 10% of
the estimated selling price/fair value.

The building was transferred to shareholders on January 31 when the prevailing fair value of the building was at
P1.3M.

Page 6 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

Required:
1. The entry to record the declaration of the property dividends would include a debit to retained earnings of
_____.
2. How much loss should be recognized in the income statement on the reclassification of the building to asset
held for disposal on the declaration date?
3. How much property dividends payable should be reported in the statement of financial; position as of
December 31?
4. What is the gain or loss to be recognized in the profit or losses as a result of the distribution of the property
dividends on January 31?
5. If the property declared as dividends are financial assets at fair market value through profit or loss, what is
the gain or loss on the settlement date?
6. If the property declared as dividends are inventories, what is the gain or loss on the settlement date?

PROBLEM 3: (ERROR CORRECTION)

Koshu Co., a calendar year entity, contained the following independent errors at the end of each reporting
period: (Amounts in thousands)

2020 2019 2018

Accounts Payable 50 under 40 under 20 over
Depreciation Expense 12 under 16 under
Merchandise Inventory 97 over 68 under 33 over
Accrued Income 33 over 25 under 45 under
Unearned Income 56 under 14 under 27 over
Advances to Suppliers 105 under 85 over 45 under
Advances from Customers 68 under 82 over 71 under
Accounts Receivable 85 under 92 over 78 under
Accrued Expense 18 under 19 over 27 under
Prepaid Expense 12 under 17 over

Compute for the following:

1. Net adjustments on 2018 and 2020 Profits

2. Effects of errors on the 2019 and 2020 Accumulated Profits

3. Net adjustments to 2018 and 2019 Working Capital

4. Adjusted total 2018 and 2020 Total Assets assuming unadjusted balances of total assets of 2018 and
2020 were P890 and P920, respectively

5. Effects of errors on 2018 and 2019 Total Liabilities

PROBLEM 4: (CHANGE IN ACCOUNTING POLICY)

Shilo Co. has been using the weighted average method of inventory costing since it began operations in 2018.
Shilo Co. has reported the following net income:

Net income Under Weighted Average Method

2018 P 400,000
2019 285,000
2020 320,000

Beginning 2021 the company decided to change the inventory cost formula to FIFO method. The following are
the December 31 inventory balances under each method:

MI, end Per Books MI, End MI, End Per Books
(Weighted Average) (FIFO) Understated By
2018 P 180,000 P 200,000 P 20,000
2019 250,000 310,000 60,000
2020 330,000 440,000 110,000

Compute for the following:

1. Restated net income for 2019 and 2020 as a result of the change in policy

2. Adjustment to the accumulated profits beginning balance of 2021 as a result of the change

Page 7 of 8 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4515
RETAINED EARNINGS

PROBLEM 5: (ERROR CORRECTION)

You are auditing the financial statements of Brin Inc. for the year 2020. The details of the unadjusted balances
of its Accumulated Profit account are as follows:

ACCUMULATED PROFIT
Date Particulars Debit Credit Balance
01.01.2018 Beginning Balance 500,000
08.31.2018 Gain on sale of treasury shares 40,000 540,000
12.31.2018 Net income for the year 200,000 740,000
02.28.2019 Payment of dividends declared in 2018 70,000 670,000
05.31.2019 Paid in capital in excess of par 20,000 690,000
07.31.2019 Loss on sale of treasury shares 30,000 660,000
12.31.2019 Net loss for the year 80,000 580,000
12.31.2020 Net income for the year 150,000 730,000
12.31.2020 Payment of dividends declared in 2019 90,000 640,000

Your examination disclosed the following:

a. Omissions at the end of each year of the following:

2017 2018 2019 2020

Merchandise Inventory, end 4,000 7,000
Accrued Expense 3,000 5,000

b. The cost of major repairs on the company’s equipment on January 1, 2018 in the amount of P150,000
was expensed outright. Remaining life of the equipment on January 1, 2018 was 6 years.

c. On January 1, 2019, the company paid an operating expense in the amount of P15,000 covering the
period, 2019 to 2021. The company charged the entire payment as outright expense and no adjusting
journal entry was ever made pertinent to this transaction.

Compute for the following:

1. Accumulated profit as of December 31, 2018 and 2020

2. Profit (Loss) for the years ended December 31, 2018 and 2019

PROBLEM 6:
1. Which of the following is not included in an audit program for the examination of the retained earnings
account?
A. Verification of the market value used to charge retained earnings to account for 10% stock dividends.
B. Verification of the approval of the adjustment to the beginning balance as a result of a change in
accounting policy involving inventory costing formula.
C. Verification of the legal appropriation for treasury share balance at year-end.
D. Verification of fair market value quotations on the grant date of stock options granted to employees still
outstanding as at year-end.

Page 8 of 8 0915-2303213  www.resacpareview.com