Question

The income statement for Pruitt Company summarized for a four-year period shows the following:

		2016		2017		2018		2019
Sales revenue	$	2,026,000	$	2,452,000	$	2,707,000	$	2,994,000
Cost of goods sold		1,489,000		1,609,000		1,779,000		2,097,000
Gross profit		537,000		843,000		928,000		897,000
Expenses		472,000		495,000		527,000		526,000
Pretax income		65,000		348,000		401,000		371,000
Income tax expense (40%)		26,000		139,200		160,400		148,400
Net income	$	39,000	$	208,800	$	240,600	$	222,600

An audit revealed that in determining these amounts, the ending inventory for 2017 was overstated by $26,000. The company uses a periodic inventory system.

1. Prepare the income statements to reflect the correct amounts, taking into consideration the inventory error.

2. Compute the gross profit percentage for each year before the correction and after the correction. (Round your answers to the nearest whole percent.)

2016-2019 Before and after correction in %

3. What effect would the error have had on the income tax expense assuming a 40 percent average rate?

	Income Tax Expense 2017 2018

Answer 1

We know, Cost of Goods sold = Beginning Inventory + Purchases - Ending Inventory
Since the ending inventory of 2017 is overstated by $ 26000, Cost of Goods sold for
2017 is understated by the same amount.
Therefore, we need to increase the cost of goods sold for 2017 by $ 26000
Now, we also know the ending inventory of the previous year is the beginning inventory
for the current year. Keeping this in mind, we can say that the beginning inventory of 2018
is also overstated by $ 26000
This will result in overstatement of cost of goods sold for 2018 by $ 26000
Therefore, we need to decrease the cost of goods sold for 2018 by $ 26000

1)	Corrected Income Statements
				2016	2017	2018	2019
	Sales revenue			$ 20,26,000.00	$ 24,52,000.00	$ 27,07,000.00	$ 29,94,000.00
	Cost of goods sold			$ 14,89,000.00	$ 16,35,000.00	$ 17,53,000.00	$ 20,97,000.00
	Gross profit			$    5,37,000.00	$    8,17,000.00	$    9,54,000.00	$    8,97,000.00
	Expenses			$    4,72,000.00	$    4,95,000.00	$    5,27,000.00	$    5,26,000.00
	Pretax income			$       65,000.00	$    3,22,000.00	$    4,27,000.00	$    3,71,000.00
	Income tax expense (40%)			$       26,000.00	$    1,28,800.00	$    1,70,800.00	$    1,48,400.00
	Net income			$       39,000.00	$    1,93,200.00	$    2,56,200.00	$    2,22,600.00

2)	Gross Profit percentage = Gross Profit / Sales
			Before	After
			Correction	Correction
		2016	27%	27%
		2017	34%	33%
		2018	34%	35%
		2019	30%	30%

3)	Effect of income tax
		Before	After		Increase/
	Year	Correction	Correction	Change	Decrease
	2017	$ 1,39,200.00	$ 1,28,800.00	$ 10,400.00	Decrease
	2018	$ 1,60,400.00	$ 1,70,800.00	$ 10,400.00	Increase

Answer 2

We know, Cost of Goods sold = Beginning Inventory + Purchases - Ending Inventory
Since the ending inventory of 2017 is overstated by $ 26000, Cost of Goods sold for
2017 is understated by the same amount.
Therefore, we need to increase the cost of goods sold for 2017 by $ 26000
Now, we also know the ending inventory of the previous year is the beginning inventory
for the current year. Keeping this in mind, we can say that the beginning inventory of 2018
is also overstated by $ 26000
This will result in overstatement of cost of goods sold for 2018 by $ 26000
Therefore, we need to decrease the cost of goods sold for 2018 by $ 26000

1)	Corrected Income Statements
				2016	2017	2018	2019
	Sales revenue			$ 20,26,000.00	$ 24,52,000.00	$ 27,07,000.00	$ 29,94,000.00
	Cost of goods sold			$ 14,89,000.00	$ 16,35,000.00	$ 17,53,000.00	$ 20,97,000.00
	Gross profit			$    5,37,000.00	$    8,17,000.00	$    9,54,000.00	$    8,97,000.00
	Expenses			$    4,72,000.00	$    4,95,000.00	$    5,27,000.00	$    5,26,000.00
	Pretax income			$       65,000.00	$    3,22,000.00	$    4,27,000.00	$    3,71,000.00
	Income tax expense (40%)			$       26,000.00	$    1,28,800.00	$    1,70,800.00	$    1,48,400.00
	Net income			$       39,000.00	$    1,93,200.00	$    2,56,200.00	$    2,22,600.00

2)	Gross Profit percentage = Gross Profit / Sales
			Before	After
			Correction	Correction
		2016	27%	27%
		2017	34%	33%
		2018	34%	35%
		2019	30%	30%

3)	Effect of income tax
		Before	After		Increase/
	Year	Correction	Correction	Change	Decrease
	2017	$ 1,39,200.00	$ 1,28,800.00	$ 10,400.00	Decrease
	2018	$ 1,60,400.00	$ 1,70,800.00	$ 10,400.00	Increase