The following data are from the 20X1 income statement of the Atiyeh Rug Emporium
ID: 2335902 • Letter: T
Question
The following data are from the 20X1 income statement of the Atiyeh Rug Emporium ($ in thousand); Sales $1,650 Deduct cost of Goods sold Beginning Inventory $390 Purchase 820 Cost of goods available for sale 1,210 Deduct: Ending inventory 370 Cost of goods sold 840 Gross profit 810 Other expenses 610 Income before income taxes 200 Income taxes expense at 40% 80 Net Income $120 The ending inventory was overstated by $20000 because of errors in physical count. The income tax rate was 40% in 20X1 and 20X2. 1. Which item in the income statement are incorrect and by how much? Use O for the Overstated, U for the Understated, and N for not affected. Complete the following tabulation “(amounts in thousands)” 20X1 20X2 Beginning Inventory N 0 $20 Ending Inventory ? ? Cost of goods sold ? ? Gross margin ? ? Income Before Income taxes ? ? Income tax expense ? ? Net Income ? ? 2. What is the dollar effect of the inventory error on retained earnings at the end of 20x1 and at the end of 20X2?
Explanation / Answer
Working note
20X1 (With error) $ in Thousands
20X1 (Assuming there was no error) $ in Thousands
Effect Understated /Overstated/ No effect
Sales
$ 1,650.00
$ 1,650.00
N
Cost of Goods Sold
Beginning Inventory
$ 390.00
$ 390.00
N
Purchases
$ 820.00
$ 820.00
N
Goods available for sale
$ 1,210.00
$ 1,210.00
N
Ending Inventory
$ 370.00
$ 350.00
O
Cost of Goods sold
$ 840.00
$ 860.00
U
Gross profit
$ 810.00
$ 790.00
O
Other Expenses
$ 610.00
$ 610.00
N
Income Before Income taxes
$ 200.00
$ 180.00
O
Income tax expense 40%
$ 80.00
$ 72.00
O
Net Income
$ 120.00
$ 108.00
O
Part 1 Answer
20X1
20X2
Understated/Overstated/ No effect
Understated/Overstated/ No effect
Beginning Inventory
N
O
Ending Inventory
O
N
Cost of Goods sold
U
O
Gross margin
O
U
Income Before Income taxes
O
U
Income tax expense
O
U
Net Income
O
U
It is assumed that when beginning inventory in 20X2 is overstated the ending inventory is valued correctly.
Part 2
Dollar effect on retained earnings at the end of year 20X1 will be (120000-108000) = $ 12000. Extra cost of $8000 (80000-72000) is paid in 20X1
Dollar effect on retained earnings at the end of year 20X2 will be $ 12000. Tax will be saved to the extent of $8000.
20X1 (With error) $ in Thousands
20X1 (Assuming there was no error) $ in Thousands
Effect Understated /Overstated/ No effect
Sales
$ 1,650.00
$ 1,650.00
N
Cost of Goods Sold
Beginning Inventory
$ 390.00
$ 390.00
N
Purchases
$ 820.00
$ 820.00
N
Goods available for sale
$ 1,210.00
$ 1,210.00
N
Ending Inventory
$ 370.00
$ 350.00
O
Cost of Goods sold
$ 840.00
$ 860.00
U
Gross profit
$ 810.00
$ 790.00
O
Other Expenses
$ 610.00
$ 610.00
N
Income Before Income taxes
$ 200.00
$ 180.00
O
Income tax expense 40%
$ 80.00
$ 72.00
O
Net Income
$ 120.00
$ 108.00
O
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