Effects of inventory error Assume that the ending inventory of a merchandising f

Question

Effects of inventory error Assume that the ending inventory of a merchandising firm is overstated by $40,000.

a. By how much and in what direction (overstated or understated) will the firm’s cost of goods sold be misstated?

b. If this error is not corrected, what effect will it have on the subsequent period’s operating income?

c. If this error is not corrected, what effect will it have on the total operating income of the two periods (the period in which there is an error and the subse- quent period) combined?

Explanation / Answer

By how much and in what direction (overstated or understated) will the firm’s cost of goods sold be misstated?

Formula for COGS goes as below:-

Beginning inventory + purchases - ending inventory = Cost of goods sold

So if ending inventory is overastaed by 40,000 so Cost of goods sold will be understated by $40,000 as we do not have other numbers for Beg inventory and purcahses

If this error is not corrected, what effect will it have on the subsequent period’s operating income?

Since the overstated amount of inventory at the end of one accounting period becomes the beginning inventory of the subsequent period, the subsequent period's cost of goods sold will be overstaed andas a result subsequent period's operating income will be low or understated.

c. If this error is not corrected, what effect will it have on the total operating income of the two periods (the period in which there is an error and the subse- quent period) combined?

If the error is not corrected in the period in which it occurred operating income will be overstated as our Cost of goods sold will be low and in the subsequent period operating income will be understated as cost of goods sold will be high.

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