Question

2016 2017

Sales $75,000 $90,000 Cost of Goods Sold 45,000 54,000 Gross Profit $30,000 $36,000 Operating Expense 15,000 15,000 Net Income $15,000 $21,000 Compute the corrected net income for 2016 and 2017 assuming that the inventory as of the end of 2016 was mistakenly understated by $7,000.

2016    2017

Corrected net income ______ _______

Answer 1

Answer.

If the ending inventory is understated, cost of goods sold is overstated, resulting in an understatement of gross margin and net income.

If at the end of year 2016, ending inventory is understated, then cost of goods sold is overstated and hence understatement of gross income/net income.

And in 2017, ending inventory of year 2016 will becomes opening inventory of year 2017, and hence understated of opening inventory in year,2017.

Now,understatement of beginning inventory result in understated cost of goods sold and hence overstated net income.

A.

Year,2016.

If ending inventory understated by $7000, then cost of goods sold becomes $45000 + $7000 i.e $52000.  

Gross profit will be: (sales - cost of goods sold)

i.e ($75000 - $52000) = $23000

Now, net income :

Gross profit - operating expenses

i.e $23000 - $15000

i.e $8000.

B.

Year,2017

If opening inventory is understated by $7000,then cost of goods sold becomes ($54000 - $7000) i.e $47000.

Gross profit : (sales - cost of goods sold)

i.e $90000 - $47000

i.e $43000.

Now, net income will be :

(Gross profit - Operating expenses.)

($43000 - $15000)

i.e $28000.