Question

Partial income statements for Sherwood Company summarized for a four-year period show the following:

	2014			2015			2016			2017
Net Sales	$	2,000,000		$	2,400,000		$	2,500,000		$	3,000,000
Cost of Goods Sold		1,400,000			1,660,000			1,770,000			2,100,000
Gross Profit		600,000			740,000			730,000			900,000

An audit revealed that in determining these amounts, the ending inventory for 2015 was overstated by $20,000. The inventory balance on December 31, 2016, was accurately stated. The company uses a periodic inventory system.

1. Restate the partial income statements to reflect the correct amounts, after fixing the inventory error.

2-a. Compute the gross profit percentage for each year (a) before the correction and (b) after the correction. (Round your answers to the nearest whole percent.)

2-b. Do the results lend confidence to your corrected amounts?

Answer 1

	Adjustment for 2015
	We know, cost of goods sold =			Beginning Inventory + Purchase - Closing Inventory
	This means, overstating closing inventory would result in an understatement of COGS
	and overstatement of Gross Profit
	Therefore, we need to increase COGS by $ 20000
	Corrected Income Statement for 2015
	Net Sales			$ 2,400,000.00
Less:	COGS	($ 1660000 + $ 20000)		$ 1,680,000.00
	Gross Profit			$    720,000.00
	Gross Profit Percentage:
	Formula		Gross Profit / Net Sales x 100
	Before Correction:
	$ 740000 / $ 2400000			31%
	After Correction:
	$ 720000 / $ 2400000			30%

	Adjustment for 2016
	We know, closing inventory of the previous year is the beginning inventory
	of the current year.
	This means that the beginning inventory is also overstated by $ 20000
	This has resulted in an overstated COGS and an understated Gross Profit
	Therefore, we need to decrease COGS by $ 20000
	Corrected Income Statement for 2016
	Net Sales			$ 2,500,000.00
Less:	COGS	($ 1770000 - $ 20000)		$ 1,750,000.00
	Gross Profit			$    750,000.00
	Gross Profit Percentage:
	Formula		Gross Profit / Net Sales x 100
	Before Correction:
	$ 730000 / $ 2500000			29%
	After Correction:
	$ 750000 / $ 2500000			30%