Question

Effects of inventory error  Assume that the ending inventory of a merchandising firm is overstated by $30,000.

Required:

a)By how much and in what direction (overstated or understated) will the firm’s cost of goods sold be misstated?

b)If this error is not corrected, what effect will it have on the subsequent period’s operating income?

c)If this error is not corrected, what effect will it have on the total operating income of the two periods (the period in which there is an error and the subsequent period) combined?

Answer 1

It is given that the ending inventory is overstated by $ 30,000.

A) if the ending inventory is overstated, then the cost of goods sold will be understated by that amount. Here, ending inventory is overstated by $ 30,000 which means that the cost of goods sold for the period is understated by $ 30,000.

B) The overstated of ending inventory of $ 30,000 will become the subsequent years opening inventory. So subsequent years beginning inventory is overstated which means that subsequent years operating income will be understated by $ 30,000.

C) the total operating income will be overstated by $ 30,000 in which the error is made. Now this overstated ending inventory will be shown in next year's opening inventory which means that next year's opening inventory is overstated by $ 30,000. If opening inventory is overstated, then the operating income will be understated. So next year's total operating income will be understated by $ 30,000.

SUMMARY :

A) Cost of goods sold is understated by $ 30,000.

B) Operating income will be understated by $ 30,000 in the subsequent year.

C) Operating income will be understated by $ 30,000 in subsequent year and overstated by $ 30,000 in the year the error made.