CHAPTER

SUBSTANTIVE TESTS OF
INCOME STATEMENT ACCOUNTS

18
18-1.

18-2.

18-3.

Red Company
Requirement (1)

Reported net income

Subtract ending inventory overstatement
Add beginning inventory overstatement
Subtract wages payable when incurred
Add wages payable when expensed
Subtract bad debts
Add back prepayments in year recorded as expense
Subtract prepayments in year expense is incurred
Correct net income

2015

2014

P 35,000

P 27,000

(2,000)
5,000
(800)
700
(400)*
200
(500)
P 37,200

(5,000)
(700)
(1,300)
500
P 20,500

* P1,700 P1,300
Requirement (2)
2016
Jan. 1

Retained Earnings
Insurance Expense
Inventory
Wages Expense
Allowance for Doubtful Accounts

4,300
200
2,000
800
1,700

18-2

Applied Auditing 2014 Edition Solutions Manual

18-4.

Orange Corporation
Requirement (1)
(1)

(2)

(3)

(4)

Allowance for Uncollectible Accounts

Administrative Expenses (37,000 19,600)
To reflect reduction in loss experience
rate.
Unrealized Holding Loss on Trading Marketable
Securities
Valuation Allowance
Retained Earnings
To reduce marketable securities to
market valuation and correct prior
years profit.
Retained Earnings
Cost of Sales
Merchandise Inventory
To adjust for overstatements in opening
and closing inventories.
a.

b.

(5)

(6)

17,400
17,400

19,000
16,000
3,000

4,000
2,100
6,100

Equipment
Operating Expenses
Retained Earnings
Accumulated Depreciation: Equipment
To adjust for error in recording of
equipment purchase in 2014 and
related depreciation for 2014 and
2015.

12,000
1,100

Accumulated Depreciation: Equipment

Equipment
Other Income
To adjust for misposting of
equipment sale.

17,500

Prepaid Expenses
Operating Expenses
Retained Earnings
To adjust for nonrecognition of prepaid
expense in 2014 and 2015.
Ordinary Shares
Capital in Excess of Par
To adjust for capital contributed in
excess of par value.

10,900
2,200

15,000
2,500

900
900
1,800

60,000
60,000

Substantive Tests of Income Statement Accounts

18-3

Requirement (2)
Orange Corporation
Computation of Corrected Net Income
For Years Ended December 31, 2015 and 2014

Reported income
Change in accounts receivable loss
experience rate
Unrealized loss (gain) on marketable securities
Ending merchandise inventories overstated:
December 31, 2014
December 31, 2015
Misposting of equipment purchase:
Decrease in operating expenses 2014
Increase in operating expenses 2015
Misposting of proceeds of equipment sold
Recognition of prepaid insurance
Corrected net income

2015
Debit (Credit)

2014
Debit (Credit)

P(220,000)

P(195,000)

(17,400)
19,000

--(3,000)

(4,000)
6,100

4,000

(10,900)
1,100
(2,500)
900

(1,800)

P(216,800)

P(206,700)

18-4

Applied Auditing 2014 Edition Solutions Manual

18-5.

XOR Corporation
XOR Corporation
Worksheet to Correct Net Profit and Balance Sheet Accounts
From 2013 to 2015
Net Profit

Unadjusted balance
Add (Deduct) Adjustments
(1) Overvaluation of inventory
2013
2014
(2) Undervaluation of inventory
2012
2015
(3) Prepaid expenses omitted at
end of year
2012
2013
2014
2015
(4) Prepaid income omitted at
end of year
2013
2015
(5) Accrued expenses omitted at
end of year
2012
2013
2014
2015
(6) Accrued income omitted at
end of year
2013
2015
Adjusted amount

2013

2014

2015

Inventory

Retained
Earnings

P 7,500

P 6,500

P 5,500

P25,000

P27,000

(7,000)

7,000
(8,000)

8,000

9,000

9,000

Adjustments to Balance Sheet Accounts

Prepaid
Prepaid
Accrued
Expenses
Income
Expenses

Accrued
Income

(6,000)
9,000

(900)
700

(400)

200
( 75)

(700)
500

(500)
600

600

(300)

(300)

100
( 50)

( 50)

600

400

75
(100)

125

(125)

P(5,850)

P 5,550

150

P22,500

P34,000

150

P36,400

300

50

P 600

P 300

P
50

150

P 150

Substantive Tests of Income Statement Accounts

18-6.

Sun Freight Company

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

a
c
c
a
a
c
a
d
a
a

P107,700
P376,800
P159,000
P320,550
P25,000
P125,000
P68,600
P179,650
P703,250
P144,250

(P112,500 P4,800)
(P204,000 P45,000)

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

18-5