Question

The CFO of the Perez Microscope Corporation intentionally misclassified a downstream transportation expense in the amount of $671,600 as a product cost in an accounting period when the company made 9,200 microscopes and sold 7,500 microscopes. Perez rewards its officers with bonuses that are based on net earnings.

Required

1. Indicate whether the elements on the financial statements (i.e., assets, liabilities, equity, revenue, expense, and net income) would be overstated or understated as a result of the misclassification of the downstream transportation expense. Determine the amount of the overstatement or understatement for each element. (If there is no effect select "Not affected" from the dropdown provided. Enter all answers as positive values.)

Assets Liabilities Retained earnings Revenue Overstated Not affected Overstated Not affected Understated Overstated Expense n Net income

Answer 1

ANSWER:

As downstream transportation expense is classified as product cost whereas it is essentially a period cost because it is part of selling cost, following are the effects of this misclassification.

Assets	overstated	($671600/9200) x (9200 - 7500) = $124100	Because ending inventory is valued at higher cost
Liabilities	not affected	-	-
Retained earnings	overstated	$124100	because expenses are understated
Revenue	not affected	-	-
Expense	understated	$124100	because transportation cost is not charged as expense
Net income	overstated	$124100	because expense are understated