Question

A company using a perpetual inventory system neglected to record a purchase of merchandise on account at year end. this merchandise was omitted from the year end physical count. how will these errors affect assets, liabilities, and stockholders equity at year end and net income for the year?

Answer 1

Answer :

Under the perpetual inventory system, we constantly update the inventory balance to match what we paid for the inventory and for what we have on hand.  We will be using ONLY 3 accounts for any journal entries as the buyer:

1. Cash
2. Inventory
3. Accounts Payable

• Cash and Inventory accounts are current assets with normal debit balances (debit to increase and credit to decrease).
• Accounts payable is a current liability with a normal credit balance (credit to increase and debit to decrease).

Under perpetual inventory system, a purchase is recorded by debiting inventory account and crediting accounts payable since the purchase is on credit. The journal entry is shown below:

Inventory account Debited	***
Accounts Payable Credited		***

Now, this entry was omitted by the merchandise from the year end and physical count. This the error of ommission which will have following impact for the year :

1) Assets - Since the Inventory is asset and purchase entry is not recorded at all therefore it will UNDERSTATE the assets of company.

2)Liability:- Accounts Payble are current liability of the company. Since the entry was not recorded at all therefore it will UNDERSTATE the current liabilities of the company.

3)Stockholder Equity : Since in the perpetual inventory system, shareholder equity is not used for purchase entries. Hence NO EFFECT.

4)Net Income : Since in the perpetual inventory system, no expense or income account is not used for purchase entries. Hence NO EFFECT.