Question

E7-19 (Algo) Analyzing and Interpreting the Impact of an Inventory Error LO7-7

Grants Corporation prepared the following two income statements (simplified for illustrative purposes):

	First Quarter						Second Quarter
Sales revenue			$	11,400							$	19,600
Cost of goods sold
Beginning inventory	$ 4,000						$	3,600
Purchases	3,400							12,200
Goods available for sale	7,400							15,800
Ending inventory	3,600							10,000
Cost of goods sold				3,800								5,800
Gross profit				7,600								13,800
Expenses				4,500								5,600
Pretax income			$	3,100							$	8,200

During the third quarter, it was discovered that the ending inventory for the first quarter should have been $4,190.

Required:

1. What effect did this error have on the combined pretax income of the two quarters?

2. Which quarter's or quarters' (if any) EPS amounts were affected by this error?

3. Prepare corrected income statements for each quarter.

4. Prepare the schedule to reflect the comparative effects of the correct and incorrect amounts on the income statement.

1. What effect did this error have on the combined pretax income of the two quarters?

2. Which quarter's or quarters' (if any) EPS amounts were affected by this error?

	1. Effect on combined pretax income 2. Quarter(s)

3. Prepare corrected income statements for each quarter.

	First Quarter Second Quarter Sales revenue $11,400 $19,600 Cost of goods sold: Beginning inventory $4,000 Purchases 3,400 12,200 Goods available for sale 7,400 12,200 Ending inventory Cost of goods sold Gross profit Expenses Pretax income

4.Prepare the schedule to reflect the comparative effects of the correct and incorrect amounts on the income statement.

	1st Quarter 2nd Quarter Incorrect Correct Error Incorrect Correct Error Beginning inventory $4,000 $4,000 No error Ending inventory 10,000 10,000 No error Cost of goods sold Gross profit Pretax income

Answer 1

Ans.

1.

The understatement of ending inventory by $ 590 produced incorrect pretax income amount for each quarter.

However, the effect is opposite on pretax income for each quarter (i.e., in the first quarter pretax income was understated by $590, and in the second quarter it was overstated by $590). This self-correcting produces a correct combined income for the two quarters.

So, there will be no effect on the combined pretax income of the two quarters because of this error.

2.

The error caused the pretax income for both quarter to be incorrect [see (1) above]; therefore, it produced incorrect EPS amounts for both (i.e First and Second) quarter.

3.

Corrected Income Statements for each quarter

	First Quarter		Second Quarter
Sales revenue		$   11,400.00		$   19,600.00
Cost of goods sold:
Beginning inventory	$             4,000.00		$     4,190.00
Purchases	$             3,400.00		$   12,200.00
Goods available for sale	$             7,400.00		$   16,390.00
Ending inventory	$             4,190.00		$   10,000.00
Cost of goods sold		$     3,210.00		$     6,390.00
Gross profit		$     8,190.00		$   13,210.00
Expenses		$     4,500.00		$     5,600.00
Pretax income		$          3,690.00		$          7,610.00

4.

	1st Quarter			2nd Quarter
	Incorrect	Correct	Error	Incorrect	Correct	Error
Beginning inventory	$          4,000.00	$          4,000.00	No error	$   3,600.00	$   4,190.00	$ 590 under
Ending inventory	$          3,600.00	$          4,190.00	$ 590 under	$10,000.00	$10,000.00	No error
Cost of goods sold	$          3,800.00	$          3,210.00	$ 590 over	$   5,800.00	$   6,390.00	$ 590 under
Gross profit	$          7,600.00	$          8,190.00	$ 590 under	$13,800.00	$13,210.00	$ 590 over
Pretax income	$          3,100.00	$          3,690.00	$ 590 under	$   8,200.00	$   7,610.00	$ 590 over