10B - Ch 9 - Inventory 2 of 2

If a material inventory error is discovered in an accounting period subsequent to the period in which the error was made... b. ___

Any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance on the statement of shareholders' equity.

If a material inventory error is discovered in an accounting period subsequent to the period in which the error was made... a. _____

Any previous years' financial statements that were incorrect due to the error are retrospectively restated to reflect the correction.

If there is an omission of goods from purchases and ending inventory... b. As stated in the problem, it results in an understatement of BOTH purchases and an understatement of ending inventory in the income statement. The errors offset when calculating COGS.

Beg Inventory + Purchases - Ending Inventory = COGS

If there is an omission of goods from purchases and ending inventory... e. _____ is overstated because of the omission of equal amounts from inventory and accounts payable. The table below shows why this is the case.

Current ratio i.e. current assets divided by current liabilities

Do prior period adjustments flow through the income statement or not ?

Prior period adjustments do not flow through the income statement but directly adjust retained earnings.

Jay Weiseman Corp. understates its ending inventory by $10,000 in 2019. As shown in the illustration, net income is misstated on the income statement for both 2019 and 2020. However, the total income combined net come for the 2 years is correct

The effect of this error is a decrease net income in 2019 and an increase net income in 2020. The error is offset in 2020 because beginning inventory is understated—causing COGS to be understated and in turn net income to be overstated.

For example, if either of beginning inventory and net purchases are overstated then cost of goods sold would also be overstated. Meanwhile, ending inventory is subtracted in the calculation of cost of goods sold, so if ending inventory is overstated then cost of goods sold is understated. These will affect ___ and ___.

The overstatement or understatement of COGS in turn will affect net income which will in turn affect retained earnings.

If there is an omission of goods from purchases and ending inventory... d. _____ is unchanged because of the omission of equal amounts from inventory and accounts payable.

Working capital i.e. current assets less current liabilities

If a material inventory error is discovered in an accounting period subsequent to the period in which the error was made... c. Finally, _____ is needed

a disclosure note is needed to describe the nature of the error and impact of its correction on net income, income before gains/losses from discontinued operations, and earnings per share.

As you can see the image, beginning inventory and net purchases are factored in the calculation of _____. For example, if either of these is overstated then ___ would also be overstated.

cost of goods sold

EFFECT OF INVENTORY ERRORS - B. Assuming a company is using the periodic inventory system, you need to understand the way ____, _____, ____ are related when analyzing inventory errors.

cost of goods sold, net income, and retained earnings

Understated or overstated ? If ending inventory is understated... c. cost of goods sold is _____

overstated because... Beg Inventory + Purchases - Ending Inventory = COGS

If the Inventory Error Is Discovered the Following Year ... The error was discovered in the subsequent year 2021. The 2020 financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correct inventory amount, COGS, net income, and retained earnings when those statements are reported again for comparative purposes in the 2021 annual report. The following journal entry ignoring income taxes corrects the error

debit retained earnings and credit inventory

Also, a disclosure note in Barton's annual report should describe the nature of the error and the impact of its correction on each year's net income like _______

overstated by $800,000 in 2020; understated by $800,000 in 2021, income before extraordinary items same as net income in this case, and earnings per share.

EFFECT OF INVENTORY ERRORS - Common inventory errors include 1. Overstatement or understatement of ____ due to mistakes in physical count or a in pricing inventory quantities.

ending inventory

Ending Inventory Misstated - Example #1 IBM correctly records its beginning inventory and purchases, but fails to include some items in ending inventory. In this case, we would have the following effects on the financial statements at the end of the period.

image

If there is an omission of goods from purchases and ending inventory... a. There is an understatement of purchases, inventory, and accounts payable in the balance sheet because the company neglected to record this journal entry. Debit to __ and credit to ___

image

If ending inventory is understated... d. COGS being overstated leads to ____ being understated because COGS is an expense item that is factored into calculating net income.

net income

When the error is discovered in 2021, the correction to retained earnings is reported as a _____ to the 2021 beginning retained earnings balance in Barton's statement of shareholders' equity.

prior period adjustment

EFFECT OF INVENTORY ERRORS - Common inventory errors include 2. Overstatement or understatement of _____ which could be caused by the cutoff errors (described in Ch. 8).

purchases

The correction of retained earnings's formula

see the image

If the Inventory Error Is Discovered Two Years Later... If the error in 2020 isn't discovered until 2022, ____

the 2021 financial statements also are retrospectively restated to reflect the correct COGS and net income even though no correcting entry would be needed at that point. Inventory and retained earnings would not require adjustment. The error has self-corrected and no prior period adjustment is needed

If there is an omission of goods from purchases and ending inventory... c. Since there is no effect on COGS, there is also no effect on net income for the period because ______

the company understates BOTH purchases and ending inventory by the same amount.

When the error is discovered... 1. If an inventory error is discovered in the same accounting period it occurred, ______ and the correct journal entry is recorded.

the original incorrect journal entry is reversed

Understated or overstated ? If ending inventory is understated... b. Current ratio i.e. current assets divided by current liabilities are _____

understated because inventory is a part of current assets.

Understated or overstated ? If ending inventory is understated... a. Working capital current assets less current liabilities are _____

understated because inventory is a part of current assets.