Question

Navajo Company's financial statements show the following. The company recently discovered that in making physical counts of inventory, it had made the following errors: Year 1 ending inventory is understated by $51,000, and Year 2 ending inventory is overstated by $21,000. $ $ $ For Year Ended December 31 (a) Cost of goods sold (b) Net income (c) Total current assets (d) Total equity Year 1 726,000 269,000 1,248,000 1,388,000 Year 2 956,000 276,000 1,361,000 1,581,000 Year 3 791,000 251,000 1,231,000 1,246,000 Required: 1. For each key financial statement figure-(a), (b), (c), and (d) below-prepare a table to show the adjustments necessary to correct the reported amounts. 2. What is the total error in combined net income for the three-year period resulting from the inventory errors?

Answer 1

The cost of goods sold (COGS) is any direct cost related to the production of goods that are sold or the cost of inventory you acquire to sell to consumers.

Formula to calculate COGS is Opening Inventory + Purchases - Closing Inventory.

In a given question, we do not have amount of Opening Inventory, Purchases and Closing Inventory, so let's assume them X,Y & Z respectively.

First Year:

Closing inventory is Understated by $51,000.00; so closing inventory would be "(Z-51,000.00)"

and as per COGS formula, the new COGS would be:

COGS = Opening Inventory + Purchases - Closing Inventory

$726,000.00 = X+Y-(Z-$51,000.00)

$726,000.00 = X+Y-Z+$51,000.00

$726,000.00 - $51,000.00 = X+Y-Z

New COGS = $675,000.00 as total of Opening Inventory + Purchases - Closing Inventory is $675,000.00.

2nd Year:

COGS is $956,000.00 i.e. it has Opening Inventory understated by $51,000.00 & Closing Inventory is overstated by $21,000.00, so we need to calculate COGS again, see below:

COGS = Opening Inventory + Purchases - Closing Inventory

$956,000.00 = (X-$51,000.00) + Y - (Z+$21,000.00)

$956,000.00 = X-$51,000.00 + Y - Z-$21,000.00

$956,000.00 + $51,000.00 + $21,000.00 = X+ Y - Z

New COGS = $1,028,000.00 as total of Opening Inventory + Purchases - Closing Inventory is $1,028,000.00.

3rd Year:

COGS is $791,000.00 i.e. it has Opening Inventory overstated by $21,000.00, so we need to calculate COGS again, see below:

COGS = Opening Inventory + Purchases - Closing Inventory

$791,000.00 = (X+$21,000.00) + Y - Z

$791,000.00 - $21,000.00 = X + Y - Z

New COGS = $770,000.00 as total of Opening Inventory + Purchases - Closing Inventory is $770,000.00.

The error in total net Income for the combined three years period resulting from the inventory errors is

1st Year : Net Income increases by $51,000.00

2nd Year : Net Income decreases by $72,000.00

3rd Year : Net Income increases by $21,000.00

So in total Net Income will not impact i.e. $0.00 will be the impacted amount.

Below is the Grid as requested:

		Year1	Year2	Year3
COGS:
Reported Amount		$726,000.00	$956,000.00	$791,000.00
Adjustment	1st year ending	-$51,000.00	$51,000.00
	2nd year ending		$21,000.00	-$21,000.00
Corrected amount		$675,000.00	$1,028,000.00	$770,000.00
Net Income:
Reported Amount		$269,000.00	$276,000.00	$251,000.00
Adjustment	1st year ending	$51,000.00	-$51,000.00
	2nd year ending		-$21,000.00	$21,000.00
Corrected amount		$320,000.00	$204,000.00	$272,000.00
Total Current Asset:
Reported Amount		$1,248,000.00	$1,361,000.00	$1,231,000.00
Adjustment	1st year ending	$51,000.00	$51,000.00
	2nd year ending		-$21,000.00	$0.00
Corrected amount		$1,299,000.00	$1,391,000.00	$1,231,000.00
Equity:
Reported Amount		$1,388,000.00	$1,581,000.00	$1,246,000.00
Adjustment	1st year ending	$51,000.00	-$51,000.00
	2nd year ending		-$21,000.00	$21,000.00
Corrected amount		$1,439,000.00	$1,509,000.00	$1,267,000.00