Question

1. Lotus Blue Pte Ltd Lotus Blue Pte Ltd uses a periodic inventory system. In its physical stock count taken at 31 December 2012, Lotus Blue's employees failed to count the merchandise in the store's window display. The cost of these merchandise amounted to $2,300. Lotus Blue reported a pretax income of $267,000 and $355,000 for the financial year ended 31 December 2012 and 31 December 2013 respectively. Required (i) Compute Lotus Blue's correct pretax income for the year ended 31 December 2012 Determine the effect of the inventory error on the total pretax income over the 2 years ended 31 December 2013. (iii) Does it matter whether the inventory error is corrected or not? Explain.

Answer 1

	i)
	Computation of Correct Pretax Income
				Year 2012	Year 2013
	Pretax Income reported			$ 2,67,000.00	$ 3,55,000.00
	Adjustment for Inventory:
	Add: Increase in gross profit in 2012 due to higher closing inventory			$       2,300.00
	Less: Decrease in gross profit in 2013 due to higher opening inventory				$     -2,300.00
	Adjusted Pretax Income			$ 2,69,300.00	$ 3,52,700.00
	ii)
	As clear from above computation, the income in 2012 was underreported due to closing inventory not recorded fully. Hence, there is increase in income for the year 2012 and relevant decrease in income of next year 2013.
	iii)
	For true and fair accounting, it is important that the inventory numbers are rectified for all the years.