Effects of InventoryErrors on Earnings
The owners of Hexagon Health Foods are offering the business for sale. The partial income statements of the business for the three years of its existence are summarized below.
| 2011 | 2010 | 2009 |
Net sales | $875,000 | $875,00 | $820,000 |
Cost of goods sold | 481,000 | 487,200 | 480,000 |
Gross profit on sales . | $393,750 | $352,000 | $340,000 |
Gross profit percentage | 45% | 42% | 41% |
In negotiations with prospective buyers of the business, the owners of Hexagon are calling attention to the rising trends of the gross profit and the gross profit percentage as very favorable elements.
Assume that you-are retained by a prospective purchaser of the business to make an investigation of the fairness and reliability of the enterprise’s accounting records and financial statements. You find everything in order except for the following: (1) An arithmetic error in the computation of inventory at the end of 2009 had caused a $40,000 understatement in that inventory, and (2) a duplication of figures in the computation of inventory at the end of 2011 had caused an overstatement
of $81,750 in that inventory. The company uses the periodic inventory system, and these errors had not been brought to light prior to your investigation.
Instructions
a. Prepare a revised three-year partial income statement summary.
b. Comment on the trends of gross profit and gross profit percentage before and after the revision.
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