Question

please help.

Xtra Inc.'s books. Xtra use an Reporting and Analyzing Inventory an and periodic FIFO. -nit in its beginning inventory. The 7/31/2019 Reporting and Analyzing Inventory BE6-9 Determine effect of inventory error for two years. (LO 4) In its year-end physical inventory count, Tire Track Corporation forgot to count tires it had stored outside its warehouse in a trailer. As a result, ending inventory was understated by $7,000. Assuming that this error was not subsequently discovered and corrected, what is the impact of this error on assets, liabilities, and shareholders' equity at the end of the current year? At the end of the next year?

Answer 1

If closing inventory is understated by $7000 then its impact during current year:

The understatement in closing stock will ultimately increase the cost of goods sold (as closing inventory is decreased from calculation of cost of goods sold) therefore it will result in decrease in/understatement of net profit by $7000

Effect in asset: as closing stock is understated (which is part of asset) therefore assets will also be understated by $7000

Effect in Shareholder Equity: As net profit is also understated by $7000 (which is added in shareholder's equity) therefore shareholder's equity will also be understated.

Effect in Liability: Shareholder equity is part of liability side and if it is understated therefore net liabilities will also be understated.

If closing inventory is understated by $7000 then its impact in next year:

closing stock of last year becomes opening stock of next year and since opening stock is added in cost of goods sold therefore in this year it will result in understatement of cost of goods sold (due to understatement of opening stock of this year)

As there is understatement of cost of goods sold, net profit will be increased or overstated.

Effect in assets: Opening stock does not reflect in assets at the end of year therefore therefore there will be no impact on assets.

Effect in Shareholder equity: The shareholder's equity was understated by $7000 last year however in this year there is overstatement of net profit of $7000 which means both are off setted and there is no impact on total shareholder's equity.

Effect in Liability: As in two years all the error are washed out/off setted and shareholders's equity is also properly stated therefore there is no impact on liabilities.

For the 2 years combined, all errors get washed out and combined effect is corrected automatically.