Question

During 2017, Rand Inc. discovered that the ending inventories reported on its financial statements were incorrect by the following amounts:

2016 $40,000 understated

2017 $50,000 overstated

Rand uses the periodic inventory system to ascertain year-end quantities that are converted to dollar amounts using the FIFO cost method. Assume that there weren’t any adjustments made for the 2016 understatement and the 2017 overstate, ignoring income taxes, what would be the amount of the overstatement or understatement in retained earnings at January 1, 2018? Assume the only type of transaction involving retained earnings was net income; there were no dividends paid in 2016 and 2017.

Answer 1

Amount of retained earnings would be overstated by 50000 at January 1,2018

Because in the year 2016 ending inventory is understated by 40000

Cost of goods sold 2016 = Opening inventory + purchases -ending inventory

so ending inventory is understated by 40000 which will understate the net income because COGS is overstated by 40000

ending inventory of 2016 would be beginning inventory of 2017 so now cost of goods sold would be decreased by 40000 and effect of 2016 understated ending inventory would be nullify

In Year 2017 ending inventory is overstated by 50000 which will reduce the cost of goods sold by 50000 will lead to increase in net income by 50000 and this will increase the balance of retained earning by 50000 on jan 1 2018