Question

The December 31, 2021, inventory of Tog Company, based on a physical count, was determined to be $465,000. Included in that count was a shipment of goods received from a supplier at the end of the month that cost $65,000. The purchase was recorded and paid for in 2022. Another supplier shipment costing $27,500 was correctly recorded as a purchase in 2021. However, the merchandise, shipped FOB shipping point, was not received until 2022 and was incorrectly omitted from the physical count. A third purchase, shipped from a supplier FOB shipping point on December 28, 2021, did not arrive until January 3, 2022. The merchandise, which cost $95,000, was not included in the physical count and the purchase has not yet been recorded.

The company uses a periodic inventory system.

Required:
1. Determine the correct December 31, 2021, inventory balance and, assuming that the errors were discovered after the 2021 financial statements were issued, analyze the effect of the errors on 2021 cost of goods sold, net income, and retained earnings. (Ignore income taxes.)
2. Prepare a journal entry to correct the errors.
  

Answer 1

ANSWER

1.

Correct Closing Inventory = Physical Inventory + FOB Inventory (Which is not in Physical Inventory)

= $465,000+ 27,500 + 95,000

Correct Closing Inventory = $587,500

2.

The purchases was understated by $160,000 ($65,000+ 95,000)

Closing Inventory Increased by $122,500($27,500 + 95,000)

So, Cost of Goods understated by = Understated Purchases – Change in Closing Inventory

Cost of Goods understated by = $37,500($160,000 – 122,500)

3.

So if the Cost of Goods is understated that means the profit is Overstated so, both Net Income and Retained Earnings will be decreased by $37,500

4.

Inventory (Dr.) 122,500

Retained Earnings (Dr.) 37,500

Accounts Payable (Cr.) 160,000

(Being errors corrected)

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