Question

Having gone through the principles II class, imagine you are an intern at Floro agro florists and its
end year. The Warehouse Manager is overwhelmed with work and realizes that you can just be
the perfect person to help him with inventory related issues after he realizes a glitch in some
year’s records. The information for the years in question has been provided as follows;
2018 2019 2020
Current Assets 1,000 1,250 1,750
Non-Current Assets 5,000 6,250 8,750
Total Assets 6,000 7,500 10,500
Long term Liabilities 2,000 2,500 3,500
Revenue 1,000 1,250 1,750
Cost of Sales 40% on cost for all the Years
Assume that ending Inventory was overstated by K1, 500 in 2018 and Understated by K10, 000
ends of 2019.
Required
a. Calculate the Cost of goods sold for the years 2018, 2019, and 2020
b. Calculate the Owners Equity value for the years 2018, 2019 and 2020
c. Calculate the correct values for the below listed items in 2018 and 2019 indicating the effect
with an explanation.
i. Current Assets
ii. Non-current Assets
iii. Total Assets
iv. Long term Liabilities
v. Owners Equity
vi. Revenue
vii. Cost of sales
viii. Gross Profit

Answer 1

a. Cost of Goods Sold:

Cost of Sales = 40% on cost

Let cost be x,

x + 0.40x = Revenue

1.4x = Revenue

x = Revenue / 1.4

Particulars	2018	2019	2020
Revenue	1,000	1,250	1,750
Cost of Goods Sold = R/1.4	714.29	892.86	1,250

b. Owners' Equity = Total Assets - Long Term Liabilities:

Particulars	2018	2019	2020
Total Assets	6,000	7,500	10,500
Effect of Ending Inventory	(1,500)	10,000	-
Effect of Beginning Inventory	-	(1,500)	10,000
Total Assets after adjustment	4,500	16,000	20,500
Less: Long Term Liabilities	(2,000)	(2,500)	(3,500)
Owners' Equity	2,500	13,500	17,000

c.

i. Current Assets:

Particulars	2018	2019	2020
Given Current Assets	1,000	1,250	1,750
Overstatement of Ending Inventory	(1,500)	-	-
Understatement of Ending Inventory	-	10,000	-
Effect on Beginning Inventory	-	(1,500)	10,000
Current Assets	(500)	9,750	11,750

ii. Non Current Assets:

Particulars	2018	2019	2020
Given Non Current Assets	5,000	6,250	8,750
Effect of Inventory	-	-	-
Non Current Assets	5,000	6,250	8,750

iii. Total Assets:

Particulars	2018	2019	2020
Current Assets	(500)	9,750	11,750
Non Current Assets	5,000	6,250	8,750
Total Assets	4,500	16,000	20,500

iv. Long Term Liabilities:

Particulars	2018	2019	2020
Given Long Term Liabilities	2,000	2,500	3,500
Effect of Inventory	-	-	-
Non Current Assets	2,000	2,500	3,500

v. Owners' Equity:

Particulars	2018	2019	2020
Total Assets	6,000	7,500	10,500
Effect of Ending Inventory	(1,500)	10,000	-
Effect of Beginning Inventory	-	(1,500)	10,000
Total Assets after adjustment	4,500	16,000	20,500
Less: Long Term Liabilities	(2,000)	(2,500)	(3,500)
Owners' Equity	2,500	13,500	17,000

vi. Revenue:

Particulars	2018	2019	2020
Revenue	1,000	1,250	1,750
Effect of Inventory	-	-	-
Revenue	1,000	1,250	1,750

vii. Cost of Sales:

Particulars	2018	2019	2020
Revenue	1,000	1,250	1,750
Cost of Goods Sold = R/1.4	714.29	892.86	1,250

viii. Gross Profit:

Particulars	2018	2019	2020
Revenue	1,000	1,250	1,750
Less: Cost of Goods Sold	714.29	892.86	1,250
Gross Profit	285.71	357.14	500

Note: In the given question, the effect of ending inventory being understated or overstated affects only the current assets and not the cost of sales or cost of goods sold. This is because cost of sales is computed as a percentage of the cost and not using the formula (COGS = Beginning Inventory + Purchases - Ending Inventory).

If the computation had been done using the formula, then the effect of the inventory would have affected cost of goods sold. But since, it is no followed in the given question, the effect of inventory affects only the ending / beginning balance of inventory, which is a part of current assets. This in turn affects the ending balances of owners' equity.

Overstatement of ending inventory must be subtracted from the ending balances and corresponding effect of the same will be reflected in the beginning inventory of the next year. Understatement of ending inventory must be added back to the inventory, the effect of which will again be adjusted in the beginning inventory of next year.

Hope this helps. Reach out to us in case you need more explanation.