Chapter 6, Problem 6APSA

Requirement 1

To determine

To calculate:

Corrected figures from (a) to (d).

Answer to Problem 6APSA

Solution:

(a).

Cost of Goods Sold	2014	2015	2016
Reported amount	$615000	$957000	$780000
Adjustment for; 12/31/2014 error	-$56000	$56000	$0
12/31/2015 error	$0	$20000	-$20000
Corrected amount	$559000	$1033000	$760000

(b).

Net income	2014	2015	2016
Reported amount	$230000	$285000	$241000
Adjustment for; 12/31/2014 error	$56000	- $56000	$0
12/31/2015 error	$0	- $20000	$20000
Corrected amount	$286000	$209000	$261000

(c).

Total current assets	2014	2015	2016
Reported amount	$1255000	$1365000	$1200000
Adjustment for; 12/31/2014 error	$56000	$0	$0
12/31/2015 error	$0	- $20000	$0
Corrected amount	$1311000	$1345000	$1200000

(d).

Total Equity	2014	2015	2016
Reported amount	$1387000	$1530000	$1242000
Adjustment for; 12/31/2014 error	$56000	$0	$0
12/31/2015 error	$0	- $20000	$0
Corrected amount	$1443000	$1510000	$1242000

Explanation of Solution

(a).

Cost of Goods Sold	2014	2015	2016
Reported amount	$615000	$957000	$780000
Adjustment for; 12/31/2014 error	-$56000	$56000	$0
12/31/2015 error	$0	$20000	-$20000
Corrected amount	$559000	$1033000	$760000

As we know when ending inventory is understated then it will show cost of goods sold at higher value. So for knowing correct amount of cost of goods sold in the year we will have to deduct $56000 from incorrect amount of cost of goods sold.

In year 2015, $56000 will be added because ending inventory of previous year will be beginning inventory for this year. So understatement of beginning inventory must be added for knowing correct amount of cost of goods sold. Apart from this overstatement of ending inventory by $20000 should be added to incorrect amount of cost of goods sold.

In year 2016, $20000 will be deducted because ending inventory of previous year will be beginning inventory for this year. So overstatement of beginning inventory must be deducted for knowing correct amount of cost of goods sold.

(b).

Net income	2014	2015	2016
Reported amount	$230000	$285000	$241000
Adjustment for; 12/31/2014 error	$56000	- $56000	$0
12/31/2015 error	$0	- $20000	$20000
Corrected amount	$286000	$209000	$261000

As we know when ending inventory is understated then it will show net income at lower value. So for knowing correct amount of net income in the year we will have to add $56000 to the incorrect amount of net income.

In year 2015, $56000 will be deducted because ending inventory of previous year will be beginning inventory for this year. So understatement of beginning inventory must be deductedfrom incorrect value of net income for knowing correct amount of net income. Apart from this overstatement of ending inventory by $20000 should be deductedfrom incorrect amount of net income because overstatement of ending inventory leads to lower amount of net income.

In year 2016, $20000 will be added because ending inventory of previous year will be beginning inventory for this year. So overstatement of beginning inventory leads to lower amount of net income that is why for knowing correct amount of net income we must add $20000 to the incorrect amount of net income.

(c).

Total current assets	2014	2015	2016
Reported amount	$1255000	$1365000	$1200000
Adjustment for; 12/31/2014 error	$56000	$0	$0
12/31/2015 error	$0	- $20000	$0
Corrected amount	$1311000	$1345000	$1200000

As we know that ending inventory is the part of current assets, so understatement of ending inventory by $56000 will lead to lower value of current assets that is why we need to add $56000 to the incorrect amount of current assets.

In year 2015, $56000 will not be considered because ending inventory of previous year becomes beginning inventory of next year and beginning inventory is not part of current assets that is why $56000 will not be considered in the year 2016. Apart from this overstatement of ending inventory by $20000 will be deducted from incorrect amount of current assets.

In year 2016, $20000 will not be considered because ending inventory of previous year becomes beginning inventory of next year and beginning inventory is not part of current assets that is why $20000 will not be considered in the year 2016.

(d).

Total Equity	2014	2015	2016
Reported amount	$1387000	$1530000	$1242000
Adjustment for; 12/31/2014 error	$56000	$0	$0
12/31/2015 error	$0	- $20000	$0
Corrected amount	$1443000	$1510000	$1242000

As we know that net income is the part of total equity. Overstatement ** understatement of ending inventory affects net income, so for knowing correct amount of equity we will have to consider impact of errors in the inventory.

In the year 2014, $56000 will be added to the incorrect amount of total equity because understated ending inventory will reduce actual value of total equity that is why for reaching to correct amount of total equity we need to add $56000 to the incorrect amount of total equity.

In the year 2015, $20000 will be deducted from the incorrect amount of total equity because overstated ending inventory will increase value of total equity that is why for reaching to correct amount of total equity we need to deduct $20000 from the incorrect amount of total equity.

In year 2016, there will be no such adjustment because ending inventory of this year does not have such errors.

Conclusion

Thus, above calculated amounts are the correct figures of cost of goods sold, net income, total current assets and total equity after making required adjustments for errors in the inventory.

Requirement 2;

To determine

To calculate:

Error in total net income for the combined three-year period.

Answer to Problem 6APSA

Solution:

Error in total net income for the combined three-year period = $0

Explanation of Solution

  $\begin{array}{l}\text{First of all let’s calculate total net income before adjustments for three-year period;}\\ \text{Total net income for three-year period (\$230000 + \$285000 + \$241000) = \$756000}\\ \text{Corrected net income for three-year period (\$286000 + \$209000 + \$261000) = \$756000}\\ \text{Thus error in total net income (\$756000 - \$756000) = \$0}\\ \text{So, it is clear that total net income before errors and after correcting errors is same }\\ \text{that is why there is no error in total net income}\text{.}\end{array}$

Conclusion

Thus, above calculation shows that there is no error in total net income for the combined three-year period.

Requirement 3;

To determine

To analysis:

Effect of the understatement of inventory on equity

Answer to Problem 6APSA

Solution:

Yes, understatement of inventory by $56000 at the end of 2014 will result into understatement of equity by the same amount in that year because understatement of ending inventory will result into higher cost of sales and as a result net income will also understated by same amount. We know that net income is the part of equity and if net income is understated then equity will also be understated by same amount in that year.

Explanation of Solution

Yes, understatement of inventory by $56000 at the end of 2014 will result into understantment of equity by the same amount in that year because understatement of ending inventory will result into higher cost of sales and as a result net income will also understated by same amount. We know that net income is the part of equity and if net income is understated then equity will also be understated by same amount in that year.

Conclusion

Thus, above given solution shows the impact of understatement of inventory on total equity. This shows that understatement of inventory will result into understatement of total equity by same amount of $56000.