Question

I have a question regarding the ramifications of not recording inventories purchased.

my question is.... if a client fails to record the purchase of inventory acquired on credit. The inventory and related creditors accounts should have been recorded but were not.

What will the effect this error will have on the following: (would one of the following be Understated / Overstated / No Effect)

Assets

Liabilities

Net Profit

Explain your answer about the effect of the error on net profit. There is an assumption that purchased inventory remains unsold.

Answer 1

When inventory is acquired on credit, then the following journal entry is required to record the purchase:-

Inventory Dr.   

Creditors Cr.

As on purchase of inventory, there will be an increase in inventory. Therefore the inventory account need to be debited and similarly a corresponding liability is due to the creditor and therefore creditors account need to be credited.

If a client fails to record the purchase of inventory acquired on credit, then the assets and liabilities will be understated and there will be no effect on net profit. The Inventory is part of current assets and not recording the purchase of inventory will result in understatement of assets. The creditors balance is a part of current liabilities and not recording the purchase of inventory acquired on credit will result in understatement of liabilities. As there is an assumption that purchased inventory remains unsold, there will be no effect on net profit of not recording the purchase of inventory acquired on credit.