Question

Effect of Errors in Physical Inventory

Fonda Motorcycle Shop sells motorcycles, ATVs, and other related supplies and accessories. During the taking of its physical inventory on December 31, 20Y1, Fonda incorrectly counted its inventory as $391,780 instead of the correct amount of $376,110.

Enter all amounts as positive numbers.

a. State the effects of the error on the December 31, 20Y1, balance sheet of Fonda Motorcycle Shop.

Balance Sheet Items	Overstated / Understated	Amount
Inventory		$
Current Assets		$
Total Assets		$
Stockholders’ Equity		$

b. State the effects of the error on the income statement of Fonda Motorcycle Shop for the year ended December 31, 20Y1.

Income Statement Items	Overstated / Understated	Amount
Cost of Goods Sold		$
Gross Profit		$
Net Income		$

c. If uncorrected, what would be the effects of the error on the 20Y2 income statement?

Income Statement Items	Understated / Overstated	Amount
Cost of Goods Sold		$
Gross Profit		$
Net Income		$

d. If uncorrected, what would be the effects of the error on the December 31, 20Y2, balance sheet?

1. The December 31, 20Y2, balance sheet would be correct, since the 20Y1 inventory error reverses itself in 20Y2.
2. In the December 31, 20Y2, balance sheet, inventory would be understated.
3. In the December 31, 20Y2, balance sheet, inventory would be overstated.
4. In the December 31, 20Y2, balance sheet, retained earnings would be understated.

Answer 1

a.  Effects of the error on the December 31, 20Y1, balance sheet of Fonda Motorcycle Shop.

Balance Sheet Items	Overstated / Understated	Amount
Inventory	Overstated	$15,570
Current Assets	Overstated	$15,670
Total Assets	Overstated	$15,670
Stockholders’ Equity	Overstated	$15,670

b. Effects of the error on the income statement of Fonda Motorcycle Shop for the year ended December 31, 20Y1.

Income Statement Items	Overstated / Understated	Amount
Cost of Goods Sold	Understated	$15,670
Gross Profit	Overstated	$15,670
Net Income	Overstated	$15,670

c. If uncorrected, Effects of the error on the 20Y2 income statement

Income Statement Items	Understated / Overstated	Amount
Cost of Goods Sold	Overstated	$15,670
Gross Profit	Understated	$15,670
Net Income	Understated	$15,670

d. If uncorrected, the effects of the error on the December 31, 20Y2, balance sheet would be as under:

The December 31, 20Y2, balance sheet would be correct, since the 20Y1 inventory error reverses itself in 20Y2.

Hence, correct option is 1.