Question

You have been hired as the new controller for the Ralston Company. Shortly after joining the company in 2021, you discover the following errors related to the 2019 and 2020 financial statements: a. Inventory at 12/31/2019 was understated by $7,400. b. Inventory at 12/31/2020 was overstated by $11,800 c. On 12/31/2020, inventory was purchased for $4,400. The company did not record the purchase until the inventory was paid for early in 2021. At that time, the purchase was recorded by a debit to purchases and a credit to cash The company uses a periodic inventory system. Required: 1. Assuming that the errors were discovered after the 2020 financial statements were issued, analyze the effect of the errors on 2020 and 2019 cost of goods sold, net income, and retained earnings. (Ignore income taxes.) 2. Prepare a journal entry to correct the errors.

Answer 1

Ending inventory understated	7400				1	Understatement of purchases			4400
					2	Beginning inventory overstated by			7400
					3	Ending inventory overstated			11800
2016					2017
Beginning Inventory	NE	0		a	Beginning Inventory	O	7400
Plus: Net purchases	NE	0		b	Plus: Net purchases	U	4400
Less: Ending Inventory	U	$7,400		c	Less: Ending Inventory	O	11800
Cost of goods sold	O	$7,400		d	Cost of goods sold (a-b-c)	U	8800
Revenues	NE	0			Revenues	NE	0
Less: Cost of goods sold	O	$7,400			Less: Cost of goods sold	U	8800
Less: Other expenses	NE	0			Less: Other expenses	NE	0
Net income	U	$7,400			Net income	O	8800
Retained earnings	U	$7,400			Retained earnings	O	8800
Journal Entry
Retained earnings A/c	Debit	8800
To beginning Inventory	Credit	8800
Being rectification entry passed for the errors incurred