Question

Capwell Corporation uses a periodic inventory system. The company's ending inventory on December 31, 2011, its fiscal-year end, based on a physical count, was determined to be $326,000. Capwell's unadjusted trial balance also showed the following account balances: Purchases, $620,000; Accounts payable; $210,000; Accounts receivable, $225,000; Sales revenue, $840,000.
The internal audit department discovered the following items:
1. Goods valued at $32,000 held on consignment from Dix Company were included in the physical count but not recorded as a purchase.
2. Purchases from Xavier Corporation were incorrectly recorded at $41,000 instead of the correct amount of $14,000. The correct amount was included in the ending inventory.
3. Goods that cost $25,000 were shipped from a vendor on December 28, 2011, terms f.o.b. destination. The merchandise arrived on January 3, 2012. The purchase and related accounts payable were recorded in 2011.
4. One inventory item was incorrectly included in ending inventory as 100 units, instead of the correct amount of 1,000 units. This item cost $40 per unit.
5. The 2010 balance sheet reported inventory of $352,000. The internal auditors discovered that a mathematical error caused this inventory to be understated by $62,000. This amount is considered to be material.
6. Goods shipped to a customer f.o.b. destination on December 25, 2011, were received by the customer on January 4, 2012. The sales price was $40,000 and the merchandise cost $22,000. The sale and corresponding accounts receivable were recorded in 2011.
7. Goods shipped from a vendor f.o.b. shipping point on December 27, 2011, were received on January 3, 2012. The merchandise cost $18,000. The purchase was not recorded until 2012.
Required:
1. Determine the correct amounts for 2011 ending inventory, purchases, accounts payable, sales revenue, and accounts receivable.
2. Calculate cost of goods sold for 2011.
3. Describe the steps Capwell would undertake to correct the error in the 2010 ending inventory. What was the effect of the error on 2010 before-tax income?

Answer 1

1. The correct amounts for 2011 ending inventory, purchases, accounts payable, sales revenue, and accounts receivable for Corporation C is calculated as follows:

Transactions discovered by Internal auditors	Correct amounts for 2011
	Ending Inventory	Purchases	Accounts payable	Sales revenue	Accounts receivable
Account balance as per Trial balance	$326,000	$620,000	$210,000	$840,000	$225,000
1		+ $32,000	+ $32,000
2		($27,000)	($27,000)
3	+ $25,000
4	+ $36,000
5	+ $62,000
6
7		+ $18,000	+ $18,000
Correct account balances	$449,000	$643,000	$233,000	$840,000	$225,000

Note:

1. Goods amount $32,000 was considered in physical count but not in purchase; therefore it should be added to the purchases and no effect on ending inventory.

2. Purchase amounting $14,000 was recorded as $41,000 but the correct amount is included in ending inventory; therefore $27,000 should be excluded from purchases and adjusted with accounts payable.

3. Goods costing $25,000 was included in purchases and related accounts payable; therefore the amount should be added to ending inventory.

4. Ending inventory included 100 units instead of 1,000 units; therefore $36,000 should be added to ending inventory.

5. In 2010 ending inventory was understated by $62,000, discovered in 2012; therefore $62,000 should be added to the inventory and retained earnings should be adjusted;

6. Goods shipped amounting $40,000 and sales are recorded properly; therefore, no adjustment is needed.

7. Goods amounting $18,000 shipped but purchase is not recorded; therefore, it should be added to the purchase and accounts payable should be adjusted.

2. Cost of goods sold for 2011 is calculated as follows:

3. Following journal entry should be passed to correct the error in the 2010 ending inventory:

The effect of the error on 2010 before-tax income is as follows:

Particulars	Effect of the error occurred in 2010 on before-tax income
Beginning inventory	-
Plus: Purchases	-
Less: Ending inventory	Understated – $62,000
Cost of goods sold	Overstated – $62,000
Revenue
Sales	-
Less: Cost of goods sold	Overstated - $62,000
Net income (Before tax)	Understated – $62,000