Question

Topic to be tested:

• Financial Statements

Learning Objectives:

• To understand the presentation of Profit and loss account/Income statement.

GDB Question:

Mr. Waseem is working as an accountant in a business organization under the name of ABC Brothers. He has recently prepared financial statements by using the data available in Trial Balance of ABC Brothers and he has presented the financial statements to the Manager accounts of the organization. Manager accounts observed the following errors in the income statement prepared by Mr. Waseem, which produce inaccurate financial affairs of business.

1. Carriage inwards of Rs. 35,000 wrongly reported under the head of selling expenses.
2. Carriage outwards of Rs. 15,000 wrongly reported under the head cost of goods sold.
3. Selling expenses of Rs. 20,000 wrongly reported under the head of administration expenses.
4. Financial expenses of Rs. 13,000 wrongly reported under the head of selling expenses.

Required:

1. What will be correct amount of Gross profit, if Gross profit before correcting the given errors was Rs. 335,000?
2. What will be correct amount of Cost of goods sold, if the reported amount of sales was Rs. 400,000?
3. What will be the effect of error “A. Carriage inwards of Rs. 35,000 wrongly reported under the head of selling expenses” on Cost of goods sold? (Just mention whether the Cost of goods sold would be overstated, understated or remains unaffected)
4. What will be the effect of given errors on net profit? (Just mention whether the net profit would be overstated, understated or remains unaffected)

Answer 1

Answer:-

1. Correct Amount of Gross Profit:-

Gross profit before correcting the errors	335,000
Less: Carriage inward wrongly reported under the head of selling expenses	35,000
Add: Carriage outwards wrongly reported under the head cost of goods sold	15,000
= Correct Amount of Gross Profit	315,000

Note:-

• Carriage inward is a direct expense and should be reported in trading account under the head cost of goods sold hence it will be deducted from gross profit.
• Carriage outward is an indirect expense and hence should not form part of cost of goods sold, so it is added back to the gross profit.

2. Correct Amount of Cost of Goods Sold:-

Amount of Sales	400,000
Less:- Correct Amount of Gross Profit	315,000
= Correct Amount of Cost of Goods Sold	85,000

3. The effect of error A on Cost of Goods Sold:-

Due to Carriage inwards of Rs. 35,000 wrongly reported under the head of selling expenses, The Cost of Goods sold would be UNDERSTATED.

4. The Effect of all errors on Net Profit:-

The Net Profit would remain UNAFFECTED. All these errors are in relation to reporting under incorrect heads of accounts hence the amount of net profit remains unaffected.