Question

Problem 5-24A Effect of inventory errors on financial statements LO 5-3

The following income statement was prepared for Frame Supplies for the year Year 1:

FRAME SUPPLIES
Income Statement
For the Year Ended December 31, Year 1
Sales	$	73,900
Cost of goods sold		(36,320	)
Gross margin		37,580
Operating expenses		(8,775	)
Net income	$	28,805

During the year-end audit, the following errors were discovered:

1. An $1,230 payment for repairs was erroneously charged to the Cost of Goods Sold account. (Assume that the perpetual inventory system is used.)
2. Sales to customers for $2,021 at December 31, Year 1, were not recorded in the books for Year 1. Also, the $1,264 cost of goods sold was not recorded.
3. A mathematical error was made in determining ending inventory. Ending inventory was understated by $1,376. (The Inventory account was mistakenly written down to the Cost of Goods Sold account.)

Required
Determine the effect, if any, of each of the errors on the following items. Give the dollar amount of the effect and whether it would overstate (O), understate (U), or not affect (NA) the account. The first item for each error is recorded as an example.

Answer 1

Answers

Error No 1	Amount of Error	Effect
Sales Year 1	NA	NA
Ending Inventory Dec 31 Year 1	NA	NA
Gross Margin Year 1	$1,230 [as COGS have increased]	Understate
Beginning Inventory Jan 1 Year 2	NA	NA
Cost of Goods Sold Year 1	$1,230	Overstate
Net Income Year 1	NA	NA
Retained Earnings Dec 31 Year 1	NA	NA
Total assets Dec 31 Year 1	NA	NA

Error No 2	Amount of Error	Effect
Sales Year 1	$2,021	Understate
Ending Inventory Dec 31 Year 1	$1,264	Overstate
Gross Margin Year 1	$757	Understate
Beginning Inventory Jan 1 Year 2	$1,264	Overstate
Cost of Goods Sold Year 1	$1,264	Understate
Net Income Year 1	$757	Understate
Retained Earnings Dec 31 Year 1	$757	Understate
Total assets Dec 31 Year 1	$757	Understate

Error No 3	Amount of Error	Effect
Sales Year 1	NA	NA
Ending Inventory Dec 31 Year 1	$1,376	Understate
Gross Margin Year 1	$1,376	Understate
Beginning Inventory Jan 1 Year 2	$1,376	Understate
Cost of Goods Sold Year 1	$1,376	Overstate
Net Income Year 1	$1,376	Understate
Retained Earnings Dec 31 Year 1	$1,376	Understate
Total assets Dec 31 Year 1	$1,376	Understate