Question

20. Irene uses a calendar-year accounting period and a periodic inventory system. Assume Irene had the following independent situations:

• Situation 1.  Goods shipped to Irene by a vendor f.o.b. shipping point on 12-28-11 were in transit at 12-31-11. The goods cost $15,000. On 12-29-11, Irene recorded a credit purchase of $15,000.
• Situation 2.  Goods shipped by Irene to a customer f.o.b. destination on 12-29-11 were in transit at 12-31-11. The goods cost  $5,000. On 12-29-11, Irene recorded a credit sale of $12,000.
• Situation 3.  Goods shipped to Irene by a vendor f.o.b. destination on 12-30-11 were in transit at 12-31-11. The goods cost $8,000. On 12-30-11, Irene recorded a credit purchase of $8,000.

Assume Irene values the inventory reported on its balance sheet and the amount recorded as cost of goods sold on its income statement on the basis of its physical inventory count that Irene performed on 12-31-11.  Irene counts whatever is on its premises.  Individually discuss the effect (in dollars and direction, e.g., overstate, understate, no effect) that each of the above items has on:

• Irene’s sales revenue for the year ended 12-31-11
• Irene’s cost of goods sold for the year ended 12-31-11
• Irene’s accounts receivable as of 12-31-11
• Irene’s inventory as of 12-31-11
• Irene’s accounts payable as of 12-31-11
• Irene’s stockholders’ equity as of 12-31-11

Situation #	I’s sales for  year ended 12-31-11	I’s COGS for year ended 12-31-11	I’s AR as of 12-31-11	I’s inventory as of 12-31-11	I’s AP as of 12-31-11	I’s SE as of 12-31-11
1
2
3

Remember, each box above should have BOTH an effect AND a $ amount.

Answer 1

Situation

I's Sales for the year ended 12-31-11

I's COGS for the year ended 12-31-11

I's A/R as of 12-31-11

I's Inventory as of 12-31-11

I's A/P as of 12-31-11

I's S/E as of 12-31-11

1

Nil

Nil

$   15,000

Overstate

Nil

Nil

$   15,000

Understate

Nil

Nil

$   15,000

Understate

2

$   12,000

Overstate

$     5,000

Overstate

$ 12,000

Overstate

$     5,000

Understate

Nil

Nil

$     7,000

Overstate

3

Nil

Nil

$     8,000

Overstate

Nil

Nil

Nil

Nil

$    8,000

Overstate

$     8,000

Understate

Explanation:-

The main issue revolves around when the ownership is transferred as per the contract. In F.O.B. Shipment, all risks and rewards are transferred to the buyer as soons as goods are shipped from the port , while in case of F.O.B. Destination, the risks and rewards are not transferred to buyer untill the destination and the risk of in-transit is borne by the seller. This basic information is required for the solution.

Situation 1) In this case, purchase is correctly recorded, but in inventory count, the inventory is missing and hence, this purchase gets treated as an increase in COGS and the Inventory is reduced from the required balance. S/E has consequential impact of COGS.

Situation 2) In this case, the contract is F.O.B. destination, but goods are still in transit and hence, sale has not occurred. This means that by booking sale prematurely, the A/R as well as Sales are overstated by $12,000. Also the goods in transit should have been accounted as closing Inventory but instead has been expensed off as COGS due to Physical counting method. Hence, it has resulted in Overstatement of COGS and Understatement of Inventroy and has also Overstated the S/E by the profit booked on sale.

Situation 3) In this case, the contract is F.O.B. destination, but goods are still in transit and hence, purchase has not occured. This means that by booking purchase prematurely, the A/P as well as COGS have been overstated by $8,000 and the S/E has consequential impact of COGS.

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