Question

Misstep Company has great expertise in some areas, but counting is not one of them. Since 2017 they have been miscounting ending inventory and applying FIFO incorrectly. Their new accountant has just discovered the errors. The records and uncorrected errors since 2017, their first year in business, are:

Year	Net Income	Ending Inventory error Over/understated	Amount
2017	$80,000	Overstated	$7,000
2018	84,000	Overstated	9,000
2019	88,000	Understated	3,000
2020	90,000	Understated	4,000

Required

1. Prepare a worksheet that shows the correct net income for each year. Indicate each change and if it is added or deducted. Part marks are based on each correct addition or subtraction.
2. Prepare a schedule that shows the correct ending retained earnings for each year.

Answer 1

A.

Note- Overstate of Opening inventory will cause reposrting of less net income , because opening inventory is added to the cost of Goods sold. Hence over statement of Cost of goods sold will cause less reported income.

- Like wise , understatement of opening inventory will cause reporting of higher net income, because now cost of goods sold will be understated causing reporting of higher Net income.

-Over statement of Closing inventory will cause reporting of higher net income. Because closing stock are not included in calculating the COGS. if closing inventory is over stated it means COGS has shown less and reported income will be more.

-Like wise understatement of Closing stock will cause reporting of less net income.

-If current year closing stock is affected then next year opening stock will also be affected in the same way , because, opening stock is noting but previous yaer closing stock.

Cause	Effect on net income
Opening stock Over stated	Net income will be less
Opening Stock understated	Net income will be more
Closing stock Over stated	Net income will be more
Closing Stock Understated	Net income will be less

	2017	2018	2019	2020
Reported Net Income	80000	84000	88000	90000
Opening stock	----	Over stated by 7000	Over stated by 9000	Under stated by 3000
Closing stock	Over Stated By 7000	Over Stated By 9000	under stated by 3000	Under stated by 4000
Effect in Net Income due to Opening stock Error	Nil	Net Income Under reported by 7000	Net income under reported by 9000	net income over reported by 3000
Effect in Net Income due to Closing stock Error	Net Income over reported by 7000	Net income over reported by 9000	Net income under reported by 3000	Net income under reported by 4000
Correct net income	=80000-7000 =73000	=84000+7000-9000 =82000	=88000+9000+3000 =100000	=90000-3000+4000 =91000

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B.

Ending Retained earnings

Year	Actual profits or Net Income	Opeing Retained Earnings	Closing Retained Earnings
2017	73000	0	73000
2018	82000	73000	155000
2019	100000	155000	255000
2020	91000	255000	346000
Ending Retained Earnings	346000