Analyzing and Interpreting the Effects of Inventory Errors (AP7-4)
The income statement for Pruitt Company summarized for a four-year period shows the following:
| 2011 | 2012 | 2013 | 2014 |
Sales revenue | $2,025,000 | $2,450,000 | $2700,000 | $2,975,000 |
Cost of goods sold | 1,505,000 | 1,627,000 | 1,782,000 | 2,113,000 |
Gross profit | 520,000 | 823,000 | 918.000 | 862,000 |
Expenses | 490,000 | 513,000 | 538,000 | 542,000 |
Pretax income | 30,000 | 310,000 | 380,000 | 320,000 |
Income tax expense (30%) | 9,000 | 93,000 | 114,000 | 96,000 |
Net income | $ 21,000 | $ 217,000 | $ 266,000 | $ 224,000 |
An audit revealed that in determining these amounts, the ending inventory for 2012 was overstated by $18,000. The company uses a periodic inventory system.
Required:
1. Recast the income statements to reflect the correct amounts, taking into consideration the inventory error.
2. Compute the gross profit percentage for each year (a) before the correction and (b) after the correction.
3. What effect would the error have had on the income tax expense assuming a 30 percent average rate ?
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