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Reo Notes - Audit Prob
Reo Notes - Audit Prob
CONCEPTS OUTLINE:
1. Cash basis accounting
2. Accrual basis accounting
3. Comparison of Cash Basis and Accrual Basis accounting
4. T-accounts approach
5. Guidelines in using T-account approach
6. T-accounts of Accounts Receivable / Notes Receivables / Advances From
7. T-accounts of Allowance for Bad Debts
8. T-accounts of Accounts Payable / Notes Payable / Advances To
9. T-accounts of Merchandise Inventory
10. T-accounts of Property, Plant and Equipment
11. T-accounts of Accumulated Depreciation
12. T-accounts of Rent Receivable / Unearned Rent Income
13. T-accounts of Prepaid Rent/Rent Payable
14. T-accounts of Capital
15. T-accounts of Retained Earnings
16. T-accounts of Net Assets
BASIC CONCEPTS
A. Definition of Cash Basis of Accounting
B. Definition of Accrual Basis of Accounting
C. Comparison of Cash Basis and Accrual Basis of Accounting
Cash to Accrual Basis
− Cash Basis Accounting is a system that recognizes revenue when cash is received and
expenses when cash is paid.
Accrual Basis Accounting
− It is an accounting system that recognizes revenue when earned rather than when cash is
received and recognizes expenses as it is incurred rather than when cash is paid.
Comparison of Cash Basis and Accrual Basis Accounting
Items of Comparison Cash Basis Accrual Basis
Includes: Includes:
Cash Sales Cash Sales
Sales Collection of Trade Credit Sales
Accounts Receivable (sale on account)
Collection of Trade
Notes Receivable
Includes only those Includes those items
Income Other Than Sales collected during the earned during the
periods period
Includes the following: Includes:
Cash Purchases Cash Purchases
Payment of Trade Purchase on
Purchases Accounts Payable Payable Account
Payment of Trade
Notes Payable
Payment in Advance
To Suppliers
Includes only those Includes those items
Expenses, In General expenses that are that are incurred
paid regardless of when
paid
Depreciation is Depreciation is
typically provided typically provided.
Depreciation except when the cost
of equipment was
treated as expense
No bad debts Doubtful accounts
expense is are treated as bad
recognized since debts.
cash basis does not
Bad Debts recognize
receivables. Although
some problem may
give an indication that
the accounts written
off were charged to
bad debts expense.
SUBTOPIC 2A
SUBTOPIC 2B
SUBTOPICS 3A
TOTAL =
SUBTOPICS 3B
SUBTOPICS 5
NOTE:
This T-account is also applicable to Prepaid Salaries / Salaries Payable.
SUBTOPICS 6A
SUBTOPICS 6B
SUBTOPICS 7B
T-ACCOUNTS APPROACH
− In order to compute for the cash payments or collections for certain account, it is suggested
that the T-account approach will be used on the following:
1. Accounts Receivable / Notes Receivables / Advances From Customers;
2. Allowance for Doubtful Accounts;
3. Accounts Payable / Notes Payable / Advances To Supplier;
4. Merchandise Inventory;
5. Property, Plant and Equipment;
6. Accumulated Depreciation;
7. Rent Receivable / Unearned Rent Income;
8. Prepaid Rent / Rent Payable;
9. Capital;
10. Retained Earnings;
11. Net Assets
CORRECTION OF ERRORS
Errors
− According to Philippine Standards on Auditing No. 240, “Error refers to an unintentional
misstatement in financial statements including the omission of an amount or a disclosure,
including:
1. A mistake in gathering or processing data from which financial statements are
prepared;
2. An incorrect accounting estimate arising from oversight or misinterpretation of facts;
3. A mistake in the application of accounting principles relating to measurement,
recognition, classification, presentation or disclosure."
Fraud
− Fraud refers to the intentional act by one or more individuals among management, those
charged with governance, employees, or third parties, involving the use of deception to obtain
an unjust or illegal advantage.
Prior Period Errors
− Prior Period Errors are omissions from, and misstatements in, the entity's financial
statements for one or more prior periods arising from a failure to use or misuse of reliable
information that:
a. Was available when financial statements for those periods were authorized for issue;
b. Could reasonably be expected to have been obtained and taken into account in
the preparation and presentation of those financial statements.
− Such errors include the effects of mathematical mistakes, mistakes in applying accounting
policies, oversights or misinterpretations of facts, and fraud.
Accounting Treatment of Prior Period Error
− According to PAS 8 par 42, "an entity shall correct material prior period errors retrospectively
in the first set of financial statements authorized for issue after their discovery by:
a. Restating the comparative amounts for the prior period(s) presented in which the
error occurred; or
b. If the error occurred before the earliest prior period presented, restating the
opening balances of assets, liabilities and equity for the earliest prior period presented.
Limitations on Retrospective Restatement
− A prior period error shall be corrected by retrospective restatement except to the
extent that it is impracticable to determine either the period-specific effects or the
cumulative effect of the error.
− When it is impracticable to determine the period-specific effects of an error on
comparative information for one or more prior periods presented, the entity shall
restate the opening balances of assets, liabilities and equity for the earliest period
for which retrospective restatement is practicable (which may be the current period).
− When it is impracticable to determine the cumulative effect at the beginning of the
current period of an error on all prior periods, the entity shall restate the comparative
information to correct the error prospectively from the earliest date practicable.
Basic Concepts in Correction of Errors
Errors affecting Net Income Effect in the Net Income Relationship
If Sales are Overstated Overstated Direct
If Cost of Sales is Overstated Understated Inverse
If Expenses are Overstated Understated Inverse
Errors affecting Cost of Sales Effect in Cost of Sales Relationship
If Beginning Inventories Overstated Overstated Direct
If Net Purchases are Overstated Overstated Direct
If Ending Inventories are Overstated Understated Inverse
Working Capital
− Working Capital is the capital of a business that is used in its day-to-day trading operations,
computed as the current assets minus the current liabilities.
Errors affecting Working Capital Effect in Working Capital Relationship
If the Current Assets are Overstated Overstated Direct
If the Current Liabilities are Overstated Understated Inverse
TYPES OF ERRORS
1. Balance Sheet or Statement of Financial Position Errors
2. Income Statement Errors
3. Combined Statement of Financial Position and Income Statement Errors
a. Counterbalancing Errors
b. Non-counterbalancing Errors
SUBTOPICS 2.1A
Balance Sheet or Statement of Financial Position Errors
− Statements of Financial Position or Balance Sheet Errors affect only the presentation of
an asset, liability, or stockholders' equity account.
− When the error is discovered in the error year, the company reclassifies the item to its proper
position.
− If the error in a prior year is discovered in a subsequent period, the company should restate
the statement of financial position of the prior year for comparative purposes.
SUBTOPICS 2.2B
Income Statement Errors
− Income Statement Errors are errors affecting only the income statement accounts and may
include improper classification of revenues or expenses.
− A company must make a reclassification entry when it discovers the error in the error year.
− If the error discovered pertains to a prior year, the company should restate the income
statement of the prior year for comparative purposes.
− Since these errors involve two nominal accounts, net income and retained earnings during
the period are unaffected.
SUBTOPICS 2.3C
Combined Statement of Financial Position and Income Statement Errors
− Errors affecting both the statement of financial position and income statement can be
classified as:
1. Counterbalancing errors and
2. Non-counterbalancing errors
1. Counterbalancing Errors
− Counterbalancing errors are errors that will offset or be corrected over two accounting
periods. Examples include the following:
Omissions of the following:
1. Deferred Expense (or Prepayments under the Expense Method.)
2. Deferred Income (Precollection under the Revenue Method.)
3. Accrued Expenses
4. Accrued Revenues
Overstatement or Understatement of the following:
5. Sales not recorded in the first year and subsequently recorded the following
year (or vice versa).
6. Purchases not recorded in the first year and subsequently recorded the
following year (or vice versa).
7. Error affecting ending inventory.
2. Non-Counterbalancing Errors
− Non-counter balancing errors do not offset in the next accounting period. Therefore,
companies must make correcting entries, even if they have closed the books.
Examples:
1. Prepayments under the Asset Method
2. Precollection under the Liability Method
3. Error in recording depreciation
4. Improper capitalization of expense
5. Improper expensing of capital expenditures
6. Error in recording of proceeds of sale of an asset (e.g. PPE) as other income
AUDIT OF CASH
Definition of Cash
− Cash includes money and other negotiable instrument that is payable in money and
acceptable by the bank for deposit and immediate credit. It includes cash on hand, demand
deposits and other items that are unrestricted for use in the current operations.
1. Cash on Hand (CUTCMoBa)
C Customer's checks awaiting deposit
U Undeposited cash collections (currencies such as bills and coins)
T Traveler's check
C Cashier's / Official / Treasurer's / Manager's checks
Mo Postal Money Orders
(a demand credit instrument issued and payable by a post office)
Ba Bank Drafts
(a written order addressed to the bank to pay an amount of money
to the order of the maker)
2. Cash In Bank
Current Account / Checking Account / Demand Deposit /
A. Commercial Deposit
Generally non-interest bearing
Withdrawable by checks against bank
Savings Deposit (Savings Account-SA)
B. Generally non-interest bearing
Depositor is issued an ATM card or passbook
Withdrawable in ATM station or within the bank
CASH EQUIVALENTS
− Cash equivalents are short-term and highly liquid investments that are readily
convertible into cash and so near their maturity that they present insignificant risk of changes
in value because of changes in interest rates. [PAS 7.6]
Items that may qualify as cash equivalents include the following:
1. Time Deposit
2. Money Market Instrument or Commercial Paper
3. Treasury Bills, Treasury Notes and Treasury Bonds
4. Redeemable Preference Shares with Mandatory Redemption Period
If the above Treatment
items are:
Originally invested / acquired for more than
three months before maturity date.
a. Remaining term is three months or Short-Term Investment
1. less from the reporting date
b. Remaining term is more than three Short-Term Investment
months but within one year
c. Remaining term is more than one year Long-Term Investment
2. Originally invested / acquired for three Cash Equivalents
months or less before maturity date
NOTE:
− If an item cannot be included as cash equivalent because it did not qualify the cut-off time
period (i.e. three months), it will always be classified as investments (short term or long term)
depending on the period up to maturity.
− The reckoning period for time deposit is its duration since time deposit generally does not
have secondary market. For other securities with secondary market, the reckoning period
would be three months from acquisition date until maturity date.
− If the problem is silent with regard to:
1. Treasury Note and Bonds — assumed non-current investment
2. Cash In Money Market Account — cash and cash equivalent
3. Time Deposit — cash and cash equivalent
ITEMS REMARKS
1. Cash − Measured at face value
2. Cash in Foreign − Should be translated to Philippine Peso using the closing rate
Currency or spot rate at the reporting date.