Task Team of FUNDAMENTAL ACCOUNTING School of Business Sun Yat-sen University Inventory errors Review the following equations that apply under both a perpetual and periodic inventory purchased purchases Purchase returns Purchase Cost of goods andallowances discounts Transportation-in Cost of goods available forsale Beginning inventory Cost of goods purchased Cost of goods sold= Cost of goods available for sale- Ending inventory Therefore Cost of goods sold=Beginning inventory Costof goods-Ending invento purchased The amount of ending inventory appears on the balance sheet, affects cost of goods sold on the current income statement (through ending inventory ) and the following years income statement(through beginning inventory ) Consequently, an error in determining the amount of inventory will affect each of these statements. Inventory errors might occur as a result of miscounting inventory items or failure to price inventory items correctly. Errors also occur due to improper recognition being given to inventory that is still in transit. For example, goods purchased FOB shipping point belong to the buyer when in transit and should be included in the buyer's Inventory In the current year, an overstatement of ending inventory results in t current assets being overstated Y cost of goods sold being understated s gross profit being overstated y net income being overstated Y owner's equity being overstated y The effect on the following year is Y cost of goods sold is overstated Y gross profit is understated 2 net income is understated s owner's equity is now properly stated An inventory error will self-correct in the following period, resulting in owners equity being properly stated after the second period Total net income over the two periods is correct, although or If gross profit is overstated in year 2 by the same amount, then owner's equity will have the correct balance after year 2 Although inventory errors self-correct, they distort managements interpretation of the earnings It to makeTask Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 3 Inventory errors Review the following equations that apply under both a perpetual and periodic inventory system: = − − + discounts Purchase andallowances Purchase returns Purchases purchased Costof goods Transportation-in Beginning inventory Cost of goods purchased available for sale Cost of goods = + Cost of goods sold = Cost of goods available for sale – Ending inventory Therefore, Ending inventory purchased Costof goods Costof goodssold = Beginning inventory + − The amount of ending inventory appears on the balance sheet, affects cost of goods sold on the current income statement (through ending inventory), and the following year’s income statement (through beginning inventory). Consequently, an error in determining the amount of inventory will affect each of these statements. Inventory errors might occur as a result of miscounting inventory items or failure to price inventory items correctly. Errors also occur due to improper recognition being given to inventory that is still in transit. For example, goods purchased FOB shipping point belong to the buyer when in transit and should be included in the buyer’s inventory. In the current year, an overstatement of ending inventory results in:  current assets being overstated  cost of goods sold being understated  gross profit being overstated  net income being overstated  owner’s equity being overstated  The effect on the following year is:  beginning inventory is overstated  cost of goods sold is overstated  gross profit is understated  net income is understated  owner’s equity is now properly stated An inventory error will self-correct in the following period, resulting in owner’s equity being properly stated after the second period. Total net income over the two periods is correct, although the allocation between periods was in error. If gross profit is overstated in year 1 but understated in year 2 by the same amount, then owner’s equity will have the correct balance after year 2. Although inventory errors self-correct, they distort management’s interpretation of the earnings trend. This may consequently lead management to make poor decisions