Question

At December 31, 2016, Stacy McGill Corporation reported current assets of $370,000 and current liabilities of $200,000. The following items may have been recorded incorrectly.

1. Goods purchased costing $22,000 were shipped f.o.b. shipping point by a supplier on December 28. McGill received and recorded the invoice on December 29, 2016, but the goods were not included in McGill’s physical count of inventory because they were not received until January 4, 2017.

2. Goods purchased costing $15,000 were shipped f.o.b. destination by a supplier on December 26. McGill received and recorded the invoice on December 31, but the goods were not included in McGill’s 2016 physical count of inventory because they were not received until January 2, 2017.

3. Goods held on consignment from Claudia Kishi Company were included in McGill’s December 31, 2016, physical count of inventory at $13,000.

4. Freight-in of $3,000 was debited to advertising expense on December 28, 2016.

Required:

a.) Compute the current ratio based on McGill's Balance Sheet

b.) Recompute the current ration after corrections are made.

c.) By which amount will income (before taxes) be adjusted up or down as a result of the corrections?

Answer 1

a) Current ratio based on McGrill's Balance sheet is

Current assets / Current liabities = $370000 / $200000 = 1.85

b) Since goods held on consignment it is considered in inventory in Claudia Kishi company and therefore it should be reduced from inventory of McGrill. On other hand if invoices are recorded by McGrill it should be included in inventory. Therefore revised current assets will be ($370000 - $13000) $357000 and revised current ratio will be $357000 / $200000 = 1.785

c) Adjustment of income as a result of corrections:

Since purchase invoices were booked even though goods were not received it should be reversed for both points 1 and 2, hence income will be adjusted upwards.

In point 3 it will not have impact on income since it will only change physical count.

In point 4 in case of freight-in of $3000 wrongly debited to advertisement account, it will not have material impact on profitability as there will be only change in ledger account but not in profit figure. It will be only considered as audit adjustment as rectification of ledger selection.

Hence overall income adjustment upwards will be of $37,000 ($22000 + $15000 adjustments in case of point 1 and 2)