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Ch 7-3 Exercises & Problems

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Effect of Errors in Physical Inventory
Fonda Motorcycle Shop sells motorcycles, ATVs, and other related supplies and accessories. During the taking of its physical inventory on December 31, 20Y8, Fonda Motorcycle Shop incorrectly counted its inventory as $294,380 instead of the correct amount of $282,600.
Enter all amounts as positive numbers.
a.  State the effect of the error on the December 31, 20Y8, balance sheet of Fonda Motorcycle Shop.
Balance Sheet ItemsOverstated / UnderstatedAmountMerchandise InventoryOverstated $Current Assets $Total Assets $Owner's Equity $
b.  State the effect of the error on the income statement of Fonda Motorcycle Shop for the year ended December 31, 20Y8.
Income Statement ItemsOverstated / UnderstatedAmountCost of Merchandise Sold $Gross Profit $Net Income $
c.  If uncorrected, what would be the effect of the error on the 20Y9 income statement?
Income Statement ItemsUnderstated / OverstatedAmountCost of Merchandise Sold $Gross Profit $Net Income $
d. If uncorrected, what would be the effect of the error on the December 31, 20Y9, balance sheet?

The December 31, 20Y9, balance sheet would be correct, since the 20Y8 inventory error reverses itself in 20Y9.

The December 31, 20Y9, balance sheet would be incorrect, since the 20Y8 inventory error understates the inventory in 20Y9.

The December 31, 20Y9, balance sheet would be incorrect, since the 20Y8 inventory error overstates the inventory in 20Y9.

Answer 1

Correct amount of inventory = $282,600

Inventory was incorrectly recorded as $294,380 in 2018.

Hence, inventory was overstated in 2018 by $11,780 i.e. 294,380 - 282,600

(a) Effect on Balance sheet of 2018

Balance sheet item	Overstated/Understated	Amount ($)
Inventory	Overstated	11,780
Current assets	Overstated	11,780
Total assets	Overstated	11,780
Owner's equity	Overstated	11,780

(b) Effect on income statement of 2018

Income statement item	Overstated/Understated	Amount ($)
Cost of merchandise sold	Understated	11,780
Gross profit	Overstated	11,780
Net profit	Overstated	11,780

(c) Effect on income statement of 2019

Income statement item	Overstated/Understated	Amount ($)
Cost of merchandise sold	overstated	11,780
Gross profit	Understated	11,780
Net profit	Understated	11,780

(d) December 31, 2019 Balance Sheet would be incorrect since 2018 inventory error overstates the inventory in 2019.