Question

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You have been asked to audit the financial statements of Clark Company and report on your findings. After examining the beginning and ending inventory counts and calculations for the current year, you find the following:

• Beginning inventory is understated by $7,600.
• Ending inventory is understated by $7,100.

Management of the company wants to know the effect that the errors will have on certain financial statement items.

Required:

Ignoring income taxes, determine the effect that the errors will have on the following:

Is the item overstated or understated? What is the amount of error? Ending inventory Overstated $ Understated Net Income Overstated

Answer 1

Beginning inventory is understated by $7,600.

Ending inventory is understated by $7,100.

Management of the company wants to know the effect that the errors will have on certain financial statement items.

Required:

Ignoring income taxes, determine the effect that the errors will have on the following:

	Is the item overstated or understated?	What is the amount of error?
Ending inventory	Understated	$7100
Net Income	Overstated	$500

*For find this we should follow the ending inventory equation

Ending inventory = beginning inventory + purchase - cost of goods sold

Cost of goods available for sales = beginning inventory + purchase

**If beginning inventory is understated by $ 7600, So, the current year cost of goods available for sales will understated by $7600. If current year cost of goods available for sales is understate, it understate the current year cost of goods sold and overstate the net income by $7600.

**However there is ending inventory is also understated by $7100, it will affect less amount are deducted from cost of goods available for sale. So the cost of goods available for sale will overstated by $7100, and the cost of goods sold will also overstated by $7100, if cost of goods sold is overstated by $7100, it will affect net income to understated by $7100

**Net effect in net income will overstated by $500

Because,

Beginning inventory understated by $7600, affect net income overstated by $7600

Ending inventory understated by $710, will affect the net income to understate by $7100

So, The net effect in Net income will overstated by $500

*In the case of ending inventory, the ending inventory only affect the Ending inventory is understated by $7,100.

*Beginning inventory is understated by $7,600, it does not affect the ending inventory.